Weekly reading – 6th February 2021

What I wrote last week

My summary of Microsoft’s latest earnings, a giant with growth momentum

My estimate on Azure revenue

Bezos is stepping down (not really a shock), but Amazon is in a great shape

Business

I don’t always agree with all Ben’s takes, but his presentation here is pretty well-done

The NYTimes looked at the current infrastructure for electric vehicles which are becoming a force in the near future

It seems that Amazon’s struggles with its Game Studio come from the top

Apple in 2020: The Six Colors report card

A profile on Kaishou

The Facebook Oversight Boardโ€™s First Decisions: Ambitious, and Perhaps Impractical. A pretty good writeup on the first 5 decisions by the FOB. I think it’s great that the FOB came out swinging to prove at least up to now it’s not for show and it’s for business. It’s also great that it doesn’t put too much weight on the operationability of its decisions. That way, the decisions seem more dialogic and as a guide instead of being contaminated by expenses and profits.

Forbes’ writeup on Chegg, a subscription company that lets you solve your homework with the help of an army of experts from India. Every business needs to make money. That I can understand. But if somebody comes out and says that it encourages cheating, they also have a point.

A story on the implosion of Ample Hills, which was once Brooklyn’s hottest ice cream brand

The latest investment letter from RGA

What I found interesting

A professional photographer took incredible photos of the glaciers in Alaska, using iPhone 12 Pro Max

Have a look at an interesting mushroom farm in Vietnam

The ridiculous lack of understanding on Section 320 from lawmakers doesn’t seem limited to Republicans because Democrats have it too

An interesting piece on Arthur Hayes, the founder of BitMEX

Interesting stats

Another horrifying story about the US healthcare. I can’t believe what I read. A new parent had to deal with their newly born child being sick and the insurance company relied on red tape and the flaws of the system to exploit their customers. Imagine the horror of receiving a $270,000 bill.

US Distilleries made $31 billion in revenue in 2020, due to Covid-19. Premium liquor rose in popularity among consumers

In 2020, nearly 1 million Gen-Zers opened a trading account at Apex Clearing, most likely through a broker, with the average age of 19.

App downloads in January 2021 from Bank of America

Someone compiled data on customers for Fintech firms

Zelle processed more than $300 billion in 2020

My estimate of Azure revenue. Its run-rate is not $28 or 29 billion yet!

Among the three biggest public cloud vendors, only Amazon provides revenue and operating income for AWS while Microsoft and Google (Alphabet) have refrained from doing the same. Alphabet (Google) will pull the curtain a little bit on the state of GCP in their imminent earnings call, but Microsoft hasn’t, even in the latest call last week. While it’s highly challenging to put a precise figure on the revenue from Azure without official disclosures, I think that by digging into their financial documents, we can have a pretty good idea of what it may be and as importantly, what it canNOT be.

If you read Microsoft’s financial filings, it can give you a headache trying to work out what all the buckets and segments mean and what goes into where. First, you can look at the business from a 4000-foot perspective into Products and Services. On a deeper level, there are three big segments: 1/ Productivity and Business Processes, 2/ Intelligent Cloud and 3/ More Personal Computing. Under each segment, there are different metrics which combine different products and services whose financial figures aren’t reported. According to Microsoft’s disclosures, Azure revenue falls into the bucket called “Server Products and Cloud Services”, as you can see in the screenshot below. Since Microsoft refuses to offer specific numbers on Azure, what we can do is to estimate it through Server Products and Cloud Services, whose numbers Microsoft does reveal.

Definition of Microsoft's metrics, including Azure
Figure 1 – The definition of Microsoft’s metrics. Source: Microsoft

Here is what Microsoft did say on Server Products and Cloud Services (SPCS) on their latest 10Q:

Server products and cloud services revenue increased $2.6 billion or 26%, driven by Azure. Azure revenue grew 50%, due to growth in our consumption-based services. Server products revenue increased 4%, driven by hybrid and premium solutions, offset in part by continued transactional weakness, on a strong prior year comparable that benefited from demand related to Windows Server 2008 end of support.

Source: Microsoft

Based on the disclosure and the composition of SPCS, we can be sure that Azure’s YoY revenue growth in the last quarter cannot be bigger than $2.6 billion. This insight can help us put a maximum limit on what Azure cannot exceed. Let’s assume that all the growth in SPCS is down to Azure and all the other products and services didn’t grow at all, meaning that Azure grew by $2.6 billion in Q2 FY2021. Because Microsoft said that Azure grew by 50%, that means its revenue in Q2 FY 2020 would have been $5.2 billion. As a result, Q2 FY2021 revenue would be $7.8 billion. Using the same logic, let’s go back to a few quarters and see what it would look like.

 1Q20192Q20193Q20194Q20191Q20202Q20203Q20204Q20201Q20212Q2021
SPCS YoY Revenue Increase $           1,562  $           1,492  $           1,710  $           1,729  $           2,134  $           2,328  $           2,437  $           1,858  $           2,003  $           2,610 
Azure Revenue Growth (100% of SPCS growth) $           1,562  $           1,492  $           1,710  $           1,729  $           2,134  $           2,328  $           2,437  $           1,858  $           2,003  $           2,610 
Azure Revenue YoY  Growth76%76%73%64%59%62%59%47%48%50%
Revenue Base $           3,617  $           3,755  $           4,131  $           3,953  $           4,173  $           5,220     
Quarterly Revenue $           3,617  $           3,755  $           4,131  $           3,953  $           4,173  $           5,220  $           6,568  $           5,811  $           6,176  $           7,830 
4-quarter revenue (annual run rate)    $        15,455  $        16,011  $        17,477  $        19,914  $        21,772  $        23,775  $        26,385 
Figure 2 – The scenario in which Azure was responsible for all Server Products and Cloud Services’ revenue growth

The first row is the revenue growth in absolute numbers every quarter of SPCS that Microsoft revealed. In this line of logic, we assume that is also the growth of Azure. Microsoft also revealed the YoY growth rate of Azure on the 3rd row. Based on the absolute numbers that we assume and the YoY growth rate, we can calculate the revenue base. For instance, the revenue base in Q2 FY2020 of $5.2 billion would be equal to $2.6 billion divided by 50% and the revenue base in Q1 FY2020 would be equal to $2 billion divided by 48%. To arrive at the estimated quarterly revenue of the last four quarter, we add the revenue base and the increase that we assumed accordingly. For instance, the $6.6 billion in Q32020 would be the sum of $4.1 billion in Q3 FY2019 and the $2.4 billion increase. Based on that logic, the absolute maximum revenue Azure could achieve in Q2 FY2021 would be $7.8 billion. If we do a quick calculation of 4-quarter revenue or what they call run-rate, the absolute maximum Azure could generate in 4 quarters would be $26.4 billion.

But since this scenario is impossible as the other components under SPCS do generate revenue growth every quarter, Azure’s run rate as of Q2 FY2021 has to be less than $26.4 billion. What would it look like if Azure’s growth was responsible for 95% of SPCS’ growth every quarter?

 1Q20192Q20193Q20194Q20191Q20202Q20203Q20204Q20201Q20212Q2021
SPCS YoY Revenue Increase $           1,562  $           1,492  $           1,710  $           1,729  $           2,134  $           2,328  $           2,437  $           1,858  $           2,003  $           2,610 
Azure Revenue Growth (if 95% of SPCS growth) $           1,484  $           1,417  $           1,625  $           1,643  $           2,027  $           2,212  $           2,315  $           1,765  $           1,903  $           2,480 
Azure Revenue YoY  Growth76%76%73%64%59%62%59%47%48%50%
Revenue Base $           3,436  $           3,567  $           3,924  $           3,756  $           3,964  $           4,959     
Quarterly Revenue $           3,436  $           3,567  $           3,924  $           3,756  $           3,964  $           4,959  $           6,239  $           5,521  $           5,867  $           7,439 
4-quarter revenue (annual run rate)    $        14,683  $        15,211  $        16,603  $        18,918  $        20,683  $        22,586  $        25,065 
Figure 3 – The scenario in which Azure was responsible for 95% of Server Products and Cloud Services’ revenue growth

Based on this assumption, the annual run-rate of Azure as of Q2 FY2021 would be $25 billion and the growth of SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub combined would be around $130 million. Lacking visibility into these products and services, I cannot say if that increase in revenue for a quarter is reasonable. What about if Azure was responsible for 90% of SPCS’ revenue growth every quarter?

 1Q20192Q20193Q20194Q20191Q20202Q20203Q20204Q20201Q20212Q2021
SPCS YoY Revenue Increase $           1,562  $           1,492  $           1,710  $           1,729  $           2,134  $           2,328  $           2,437  $           1,858  $           2,003  $           2,610 
Azure Revenue Growth (if 90% of SPCS growth) $           1,406  $           1,343  $           1,539  $           1,556  $           1,921  $           2,095  $           2,193  $           1,672  $           1,803  $           2,349 
Azure Revenue YoY  Growth76%76%73%64%59%62%59%47%48%50%
Revenue Base $           3,255  $           3,379  $           3,717  $           3,558  $           3,756  $           4,698     
Quarterly Revenue $           3,255  $           3,379  $           3,717  $           3,558  $           3,756  $           4,698  $           5,911  $           5,230  $           5,558  $           7,047 
4-quarter revenue (annual run rate)    $        13,910  $        14,410  $        15,729  $        17,922  $        19,594  $        21,397  $        23,746 
Figure 4 – The scenario in which Azure was responsible for 90% Server Products and Cloud Services’ revenue growth

Under this scenario, Azure’s run rate would be $23.7 billion and all the other products under SPCS would contribute around $260 million in revenue growth in the last quarter. For the same reason stated above, I am unable to say if the latter figure is correct, but you can use the same rationale and play around with assumptions to get an estimate of how big Azure can be.

In the Q1 FY2021 earnings call, an analyst commented that Azure revenue made up 17% of Microsoft’s total revenue; which the Executives didn’t comment on:

Figure 5 – A comment from an analyst on Azure from the Q1 FY2021 Earnings Call. Source: Fool.com

If that estimate is true, this will be Azure’s quarterly revenue

 1Q20192Q20193Q20194Q20191Q20202Q20203Q20204Q20201Q20212Q2021
Total Revenue $        29,084  $        32,471  $        30,571  $        33,717  $        33,055  $        36,906  $        35,021  $        38,033  $        37,153  $        43,076 
Azure Revenue (17% of total revenue) $           4,653  $           5,195  $           4,891  $           5,395  $           5,289  $           5,905  $           5,603  $           6,085  $           5,944  $           6,892 
Figure 6 – What 17% of Microsoft’s total revenue looks like

The number in Q1 FY2021 ($5.9 billion) isn’t so far off what we had in the 95% scenario above. While nobody, except the people at Microsoft, can say for sure what Azure revenue is, I think it’s fairly likely that its run rate is about $25 billion as of Q2 FY2021.

Disclaimer: I own Microsoft stocks in my portfolio.

Microsoft – A well-oiled, expertly run and growing giant

Microsoft is one of the three tech giants, along with Facebook and Apple, that reported a blow-out quarter this past week. What impressed me is that Microsoft is a giant that recorded $43 billion as quarterly revenue in Q2 FY2020 AND grew at an unbelievable clip of 17% YoY for a company that size….AND showed improved efficiency with the operating margin of 42% in the latest quarter. Looking deeper at the segments, they have all exhibited growth, especially their Office Products, Cloud, Server Products and LinkedIn.

Some of their notable and strategic products continue to show their strengths. Microsoft 365 Consumer Subscriber Base stood at 47.5 million in Q2 FY2021 and its YoY growth is the highest since FY 2018. Even though its YoY growth has been hampered by the law of big numbers, Azure hasn’t seen this number dip below 40% since FY 2017. Teams, the product that has attracted a lot of attention so far during the pandemic, also saw great adoption from corporations and had 115 million Daily Active Users as of Q1 2021.

I created some charts here that hopefully can help show what an incredible business Microsoft is right now.

Microsoft's quarterly revenue
Figure 1 – Microsoft’s quarterly revenue. Source: Microsoft
Microsoft's segment revenue
Figure 2 – Microsoft’s segment revenue. Source: Microsoft
Microsoft's operating margin
Figure 3 – Microsoft’s operating margin. Source: Microsoft
Microsoft segments operating income, including Productivity & Business Processes, Intelligent Cloud and More Personal Computing
Figure 4- Microsoft’s segment operating income. Source: Microsoft
Microsoft's consumer subscriber base and YoY growth
Figure 5- Microsoft 365 Consumer Subscriber Base and YoY Growth. Source: Microsoft
Azure YoY Growth
Figure 6- Azure YoY Growth. Source: Microsoft
Teams adoption from corporations
Figure 7 – Teams adoption among corporations. Source: Microsoft

Disclaimer: I own Microsoft stocks in my portfolio

Weekly readings – 26th September 2020

What I wrote

Some data points and arguments in favor of Apple and its App Store guidelines

My review of the book: The Psychology of Money

Business

How Wegmans Keeps Winning

A bear case on Microsoft Azure

Innovation is rampant in the fintech world and this new idea for a credit card is one of them

An investigative piece on how Mark Zuckerberg responded to criticisms from his own ranks

The SaaS Financial Model Youโ€™ll Actually Use

Technology

The secret history of Windows on Surface Duo

Adobe introduced Liquid Mode in even Free Adobe Acrobat Reader! It makes changing a PDF’s content so much easier. Try it out!

What I found interesting

In the last 30 years, under-5 child mortality rate has dropped from 93 per 1000 children in 1990 to about 38 in 2019. A remarkable achievement

About a special Japanese citrus

South Korea managed to contain the pandemic while minimizing the impact on its economy. WSJ had an interesting piece on how it did so

Today I learned – 30th Jan 2020

Rise of contactless payment reported by Visa and Mastercard

It is so much faster and easier to just tap your card or phone on a reader than to use the chip or swipe. The frictionlessness of this payment method has clearly wowed users enough that it is on a rise, especially in the US.

In the card-present environment, we continue to see meaningful momentum in tap to pay, what we consider to be the most friction-free way to pay in person. We have reached a point where 1 in every 3 card-present transactions that runs over our network is [tax] versus 1 in 4 a year ago this quarter. This past year, we’ve doubled the number of countries whose face-to-face transactions are at least 2/3 contactless.

Transit continues to be a key user case and an important way to habituate tapping behavior. In New York City, on the NPA, Visa crossed 2 million taps in November from the beginning of the pilot and 3 million in January. The FDA recently announced the tap-to-pay expansion to their entire system by the end of 2020, and we are currently pacing a 350,000 Visa taps a week on the MTA and nearly 1 in every 10 transactions in the New York Metro area is a tap-to-pay on a Visa card.

Source: Visa in its Q1 2020 Earnings Call Transcript, provided by Atom Finance

Echoing the sentiment was Mastercard in its Q4 2019 Earnings Call

..On to contactless, where as I said, we’re making real progress. This quarter, contactless made up over 30% of global card-present purchased (inaudible). Contactless provides a frictionless and fast payment experience, which is opening new categories of spend, including displacing cash on small-ticket purchases. The U.S. point for growth on this front and the New York City MTA is a good example of the potential for rapid adoption by consumers. In fact, they surpassed 5 million taps since the launch in May. And the MTA has planned to roll out contactless acceptance system-wide by the end of 2020.

I’m pretty certain that U.S. contactless will keep growing throughout 2020 quite attractively. Because if you look at the numbers of the number of bank partners that have committed to issue contactless cards for a [minute], let’s even forget Apple Pay and Samsung Pay that enable every card through their archive to be used. If you just look at the number of cards, we are talking about 70% of our total cards in the U.S. market will be reissued over this 12-month to 14-month period. My own personal cards are already contactless from Citi.

On the acceptance side, kind of all new terminals going on are embedded with contactless. So (inaudible) large retailers Target and 7-Eleven and CVS have announced that they will accept contactless payments. And in fact, over half of U.S. card-present transactions are now happening at contactless-enabled merchant locations. And when the MT rolls in on system-wide in New York City, and there are other transit systems beginning to do the same in their cities, I think you will get the impetus.

Source: Atom Finance

Vietnam as an important emerging market for Apple

My country was mentioned repeatedly in the latest earnings call of Apple. In a positive light that makes me think that we are going to be, if we are not already, an important emerging market for the Cupertino-based company

Geographically, we established all-time revenue records in many major developed and emerging markets including, among others, the U.S., Canada, Mexico, Brazil, the UK, Germany, France, Italy, Spain, Poland, Thailand, Malaysia and Vietnam.

Source: Seeking Alpha

For iPad, we saw growth in key emerging markets like Mexico, India, Turkey, Poland, Thailand, Malaysia, the Philippines and Vietnam

Source: Seeking Alpha

Phone revenue of $56 billion grew 8% year-over-year, as we saw a great customer response to the launch of our newest iPhones. We set all-time revenue records in several countries, including the U.S. Mexico, the UK, France, Spain, Poland, Thailand, Malaysia and Vietnam.

Source: Seeking Alpha

Productivity and Business Processes keeps leading the margin game for Microsoft

Microsoft has three main business lines:

  • Productivity & Business Processes that includes Office 365 Commercial and Consumer, LinkedIn and Dynamics
  • Intelligent Cloud that includes server products and cloud services led by Azure, and Enterprise service
  • More Personal Computing that includes Gaming, Search, Windows and Surface

Azure likely receives the most attention, yet it is Productivity & Business Processes (PBP) that consistently took the crown in the margin game at Microsoft. In the latest earnings report, Microsoft reported almost 44% margin for PBP

Source: Microsoft
Source: Microsoft

Even though there have been only 2 quarters so far in 2020, the segment has generated more revenue and operating income than the full year 2019

Source: Microsoft

Notable statistics from Microsoft Q4 FY19 Earning Calls

Since I am taking notes while reading through Microsoft’s earning call transcript, I thought: why not sharing it here?

  • Microsoft Teams 13 million daily active users and 19 million weekly active users. In March, it was reported that Teams is used by 500,000 organizations
  • GitHub is used by more than 36 million developers
  • 54 data Center regions, more than any other cloud provider and we were the first in Middle East and in Africa
  • More than 90% of Fortune 500 use Power or Dynamics 365
  • LinkedIn has 645 million members
  • Windows 10 is active on more than 800 million devices
  • Xbox Live Monthly Active Users increased to a record 65 million
  • Microsoft Azure’s contracted not realized revenue is $91 billion
  • There are 34.8 million Office 365 consumer subscriptions
  • LinkedIn revenue increased 25% and 28% in constant currency with continued strength across all businesses, highlighted by marketing solutions growth of 42%. LinkedIn sessions grew 22%, with record levels of engagement and job postings again this quarter.
  • Free cash flow increased by 62% YoY to $12 billion in Q4 FY 19. FCF for the fiscal year 2019 is $$38 billion, 18% growth compared to FCF of fiscal year 2018
  • Xbod hardware revenue dropped by 48% while Xbox service and software revenue slipped by 3%
Source: Microsoft

Facebook & Privacy First Mentality

Quite a week for Facebook

It has been quite a few days for Facebook. First, two days ago onย Techcrunch:

Facebook has confirmed it does in fact use phone numbers that users provided it for security purposes to also target them with ads.

Specifically a phone number handed over for two factor authentication (2FA) โ€” a security technique that adds a second layer of authentication to help keep accounts secure.

Then, a bombshell was dropped yesterday. Per Wired:

ON FRIDAY, FACEBOOK revealed that it had suffered a security breach that impacted at least 50 million of its users, and possibly as many as 90 million. What it failed to mention initially, but revealed in a followup call Friday afternoon, is that the flaw affects more than just Facebook. If your account was impacted it means that a hacker could have accessed any account that you log into using Facebook.

Facebook’s track record in data security and privacy hasn’t been particularly stellar recently. 2018 is not 2010. Facebook doesn’t have the same dominant position as it used to in the social network market any more. Users have plenty of alternatives and substitutes to spend their time on. These scandals, coupled with its role in the “free speech vs hate speech” row, don’t do any good to Facebook’s image as well as its appeal to users when privacy has become more and more pressing as a concern to users.

Privacy & regulations

I have been resigned to the fact that there is no anonymity on the Internet and that complete privacy isn’t possible. Yet, when users trust a company with their data, whatever the data is, it’s the company’s responsibility to protect such data. As many important aspects of our lives take place on the Internet, the need to feel safe online is more overwhelming than ever. Without feeling safe, how could users feel comfortable using a service? Privacy and data security will be, if not already is, expected by default of companies. It’s not a nice-to-have feature any more. It’s a do-or-see-your-competitors-get-ahead game.

But companies are not in the business to lose money. If they are not legally required to bolster their security, don’t expect them to. That’s why companies fought hard against GDPR or privacy laws passed in California this year. And this is where I don’t understand the criticisms of some towards regulations such as GDPR. Yes, no law is perfect, especially in the beginning. That’s why we have amendments. GDPR is not an exception. It is a great first step to give power back to users and force companies to be liable for their actions/inactions.

A common criticism that I came across towards GDPR is that it makes it too expensive for small companies and startups to comply, widening the moat or competitive advantage gap between giants such as Google/Facebook and SMBs. Well, if a company with a deep pocket and better security measures has 10% of its 500,000 in user base breached, the impact is 50,000 users. If a small company with fewer recourses and much weaker security measures loses all of its 50,000 users, the impact is the same as in the first scenario. Hence, breaches at SMBs can have significant damages and ramifications as well.

Sure, the best case scenario is to have different levels of compliance applied to companies of different size. I’d love to see that happen. Nonetheless, without privacy regulations, imagine how much companies would care about our data and how much of a mess it would be. Despite having HIPAA in place, every year has been a banner year of cybersecurity in healthcare in the US and healthcare organizations spend 3% of their IT budget on cybersecurity. Verizon reported in their 2018 Payment Security Report that only 40% of all interviewed companies in North America maintained full compliance with PCI. Despite all the scandals related to data security in the past, Facebook still lets more unfortunate events happen. To be fair, I don’t imagine having impeccable security is easy. However, would companies even try to secure your data without any legal requirements?

Progress happens when we raise standards. Would cars be more environmentally friendly if we hadn’t enforced regulations on emission quality? If a university wants to raise its standard for incoming students, will it lower or raise the requirement for GMAT/SAT? Will a drug be safer for patients if the FDA enforces more or fewer tests? Big companies have the means to comply with stringent privacy regulations. Small companies/startups, though difficult, have more access to capital funding. Plus, public cloud providers are investing to have their infrastructure compliant with many compliance regulations (See more here for AWS compliance and Azure compliance). Regardless of size, companies have to take privacy seriously and consider it an integral piece of the puzzle, a competitive advantage if done right or a threat to their competitiveness if ignored.