Hyperscalers Q4 Reports

We have now heard from all of the hyperscalers and the message across the board is quite clear - cloud growth is slowing. A year ago, AWS, GCP and Azure averaged 44% annual growth. Today, that figure has dropped to 27% and is undoubtedly headed lower. To be fair, these businesses are behemoths and at some point, growth was going to have to drop but it is the sharpness of the decrease has surprised me. I believe this is the canary in a coal mine for the smaller cloud business we typically invest in. Things are going to get choppy.

Microsoft Azure:

Revenue Growth: Azure and other cloud services revenue grew 31% and 38% in constant currency. The good news is they beat their guidance for Azure this quarter, unlike they did the previous quarter. The bad news is, this is the third consecutive drop in growth, down from 42% last quarter and 46% the previous year (in a constant currency basis).

Forecast: ~30-31% YoY. I wrote last quarter that it was obvious Azure was seeing a slowdown and that has has turned out to be true and then some. Based upon the comments during the call, it does not sound like this trend will reverse anytime soon - “we exited Q2 with Azure growth in the mid-30s in constant currency. And from that, we expect Q3 growth to decelerate roughly four to five points in constant currency.

Google Cloud:

Revenue Growth: Revenues were $7.3 billion for the quarter, up 32% YoY. This is a drop from 38% last quarter and 45% last year. What is more concerning, however, was the sequential growth. This dropped from 9.4% to 6.6% and is down from 11% last year. Similar to Azure, GCP is seeing a clear slowdown - “In Q4, we saw slower growth of consumption as customers optimized GCP costs, reflecting the macro backdrop.”

Google Cloud revenue includes G Suite and is not in constant currency. And like previous quarters, the CFO mentioned the Google Cloud Platform (GCP) grew faster than the overall cloud.

Google does not share a forecast for GCP however, their focus for 2023 will be getting this business profitable. Unlike Azure and AWS, GCP is not yet profitable (although it is much smaller). Google is going to shift their focus in cloud from growth at all cost to delivering profitability this year. This is reminiscent of what we are seeing from our companies such as Bill and Cloudflare.

Amazon AWS:

Revenue Growth: Sales were $21.4 billion in Q4, up 20% YoY. This is a decrease from 27% last quarter and 40% last year. Again, I am most concerned when looking at the sequential numbers. Q4 is generally Amazon’s strongest. The average of the previous four Q4’s sequential growth rate was 10.5%. This quarter, it was 4.1%.

In Q4 last year, AWS added over $5B in revenue YoY. This quarter they only added $3.6B in revenue. They added nearly $1.5B less in raw dollars this year while at a much larger scale. This kind of drop is unprecedented in the history of AWS. To say this was AWS’s worst quarter ever from a growth perspective would be putting in lightly.

Here is what the CFO had to say regarding AWS and the forecast:

Starting back in the middle of the third quarter of 2022, we saw our year-over-year growth rates slow as enterprises of all sizes evaluated ways to optimize their cloud spending in response to the tough macroeconomic conditions. As expected, these optimization efforts continued into the fourth quarter. Some of the key benefits of being in the cloud compared to managing your own data center are the ability to handle large demand swings and to optimize costs relatively quickly, especially during times of economic uncertainty. Our customers are looking for ways to save money, and we spend a lot of our time trying to help them do so.

As we look ahead, we expect these optimization efforts will continue to be a headwind to AWS growth in at least the next couple of quarters. So far in the first month of the year, AWS year-over-year revenue growth is in the mid-teens.

If AWS were to end up reporting revenue growth in the mid-teens next quarter, this would mean their sequential revenue would be flat or decline. In other words, it is going from bad to ugly.

Naturally, it did not take long for analyst to snuff this out and the first question went straight to addressing this:

Justin Post – Bank of America Merrill Lynch – Analyst

AWS, if you look at the revenue growth of mid-teens, it implies it could be flattish and even down this quarter.

So maybe talk about what’s driving that. Is it workload changes? Are there some clients that are shifting? Anything on the market share you could comment on? And then second, when do you think this could recover? Like what’s the time frame?

Andy Jassy – Chief Executive Officer

I think most enterprises right now are acting cautiously. You see it with virtually every enterprise, and we’re being very thoughtful about streamlining our costs as well. And when you are being cautious, you look for ways that you can spend less money.

It’s one of the advantages that we’ve talked about since we launched AWS in 2006 of the cloud, which is that when it turns out you have a lot more demand than you anticipated, you can seamlessly scale up. But if it turns out that you don’t need as much demand as you had, you can give it back to us and stop paying for it. And that elasticity is very unusual.

It’s something you can’t do on-premises, which is one of the many reasons why the cloud is and AWS are very effective for customers.

I think it’s also useful to remember that 90% to 95% of the global IT spend remains on-premises. And if you believe that, that equation is going to shift and flip, I don’t think on-premises will ever go away, but I really do believe in the next 10 to 15 years that most of it will be in the cloud. It means we have a lot of growth in front of us in the AWS business.

My Thoughts

The sentiment is pretty consistent across the board - a sharp slowdown is here and likely going to continue at least for the next couple quarters, but the long-term trend is still intact. Based off these reports, plus the limited data we have seen from companies like Bill, ServiceNow and Atlassian, I am lowering my expectations for our companies.

Due to the tightening of IT budgets, I fully expect all my companies to report slower growth in 2023. Some, such as Datadog, will likely report much slower growth. I believe the next few quarters will be particularly challenging for our cohort of companies.

As I think more about this, I am starting to shift my focus beyond the next few quarters and further into the future. The reason being, I want to own companies who I think have durable growth and are the likeliest to see revenue growth accelerate once this difficult environment is behind us. Additionally, I want to see proven evidence that these business have a clear path to profitability and will be able to produce significant cash flows into the future.

These are the four business I believe fit this mold:

  • Datadog and Snowflake - I view these businesses as best of breed and due to the consumption based aspect of their business model, I believe there is a good chance they will see revenue growth accelerate as IT budgets begin to expand again. Both are already achieving ~20% FCF margin.

  • The Trade Desk - they are doing a great job grabbing market share and are very well positioned to ride the CTV wave for years to come. I believe this could lead to accelerating growth once advertising budgets return. Their profitability is already well established.

  • Bill - I am less confident on this one so it has a lower allocation but I believe they are well poised to see growth accelerate as the macro environment improves due to the fact that 2/3 of their revenue is transactional. So long as they continue to add a solid number of customers, they should be well positioned to achieve higher growth. They made excellent strides towards profitability this quarter and I expect this trend to continue.

Ultimately, if the hyperscalers are any guide, things are going to get uglier for our companies. My goal remains the same, own the best businesses who are well positioned to significantly grow revenue and FCF for years to come.


Q3: Hyperscalers Q3 Reports
Q2: MSFT & GOOG Cloud Growth Strong


Peter Offringa (Software Stack Investing) posted his hyperscalers earnings review last week.

I would highly encourage those interested to check his post out. He analyzes the results in much greater detail and provides context about the ongoing optimizations faced by the hyperscalers. He can run circles around me with his knowledge of this industry.

Here is my main takeaway and favorite tidbit from his article:

While the situation looks dismal in the current quarter, I expect growth rates to level out in the second half of the year and sequential growth to pick back up again. This assumption is based on the observation that workload optimization is generally a one-time exercise and front-loaded. Teams will quickly work through the low hanging fruit, reducing the headwind of smaller bills for existing workloads. Further, new workloads will start to ramp up, increasing cloud spend again.

In addition to the hyperscaler’s reports, he also included a shorter review of other SaaS businesses who already reported and had this to say:

The other indicator providing some optimism for the second half of the year comes from the earnings results of the few software infrastructure companies that have reported thus far. Dynatrace, Confluent, ServiceNow and Atlassian provided revenue growth projections further out in 2023 than the hyperscalers. These imply smaller deceleration in first half of the year, and then leveling of growth rates or even slight re-acceleration in the back half.

Lo and behold, Cloudflare proceeded to follow this trend with their guidance and commentary regarding 2023. It appears this could be the norm for our companies as they continue to report their year end quarter.

I strongly recommend others to check out Peter’s review and other articles on his website as they are all fantastic.