Cloud computing, meet cloudy numbers.
After years of asking investors to take its artificial-intelligence strategy on faith, Microsoft stands out among tech giants for the opacity of its financial reporting.
Across three critical drivers of its AI future-cloud computing, capital expenditures and its relationship with OpenAI-the company's disclosures fall well short of what investors need.
Take Azure, Microsoft's flagship cloud platform and primary growth engine. Management should provide clear financial visibility but instead keeps everyone in the dark.
Microsoft in its latest annual report said that "Azure and other cloud services revenue increased 41%" during the fiscal year ended June 30. It gave no dollar amount for that revenue, nor the year earlier figure, nor any expense or profit data for Azure. On Microsoft's July earnings call, Chief Executive Satya Nadella offered a rare data point, saying Azure's annual revenue topped $100 billion. But cherry-picking a milestone on a call isn't the same as reporting an audited number.
Instead, Microsoft buries Azure inside a segment called "Intelligent Cloud" that includes legacy software, forcing investors to guess where the legacy products end and the real cloud growth begins. By contrast, Amazon.com reports Amazon Web Services, the world's biggest cloud provider, as a stand-alone segment with sales, expenses and margins disclosed. Azure is second, yet its finances remain a black box.
While Microsoft's lack of transparency has long drawn complaints, its rapid shift to a capital-intensive business model gives the issue newfound weight.
Even a familiar metric such as capital expenditures becomes elusive. Additions to property and equipment on the cash-flow statement totaled $115.9 billion last year, which is the figure Microsoft used to calculate free cash flow. But in an accompanying release, Microsoft reported capex of $145.3 billion, including assets acquired under finance leases. While Microsoft discloses figures for finance leases, adding them to the cash paid for property and equipment doesn't tie out to the $145.3 billion total, and the company provides no reconciliation.
Microsoft's segment reporting has the greatest consequence for investors. The capital spending is going mainly toward Azure, the platform built on a vast network of data centers that underpins much of the modern web and powers AI models.
By tucking Azure inside Intelligent Cloud, Microsoft hides the margins, costs and capital intensity of its AI build-out. Doing so mixes the costly AI-infrastructure engine with a high-margin software business, masking Azure's profitability.
Intelligent Cloud is one of three operating segments at Microsoft, generating 42% of sales last year. Its revenue jumped 30% to about $138 billion, while cost of revenue rose 44% to $58 billion and operating expenses increased 7% to $23 billion. That left operating income of about $57 billion, up 28%.
Azure's results are encased somewhere in those numbers. Microsoft chooses not to report them. However, it provides granular detail about far smaller businesses like Xbox and LinkedIn, which generated about $22 billion and $20 billion in revenue last year, respectively.
Microsoft has had plenty of chances to change course. Three years ago, Azure's revenue leaked in court records from a government lawsuit. An internal report from June 2022 showed Azure's fiscal 2022 revenue was estimated at $55 billion, including $34 billion from infrastructure. That established that Azure's true numbers exist, and management tracks them.
Microsoft could have reported Azure separately from that point forward. Instead, it later rearranged portions of its segment reporting, so today's segment results aren't comparable with those from fiscal 2022.
It is debatable whether Microsoft should be allowed to hide the ball this way. Accounting rules dictate that companies report segments based on how the "chief operating decision maker" assesses performance and allocates resources. At Microsoft, that person is Nadella. Azure is an entirely different business from legacy software like Windows Server, and Nadella obviously distinguishes between AI data centers and software licensing when making capital decisions. Yet Microsoft lumps them together anyway.
OpenAI's widely anticipated initial public offering could help force the transparency issue. Microsoft owns 25% of the ChatGPT developer and has identified it as an equity-method investment. That means OpenAI, by definition, is a related party, and Microsoft can exercise significant influence over it. Yet Microsoft's filings didn't include related-party disclosures regarding OpenAI until the latest annual report, which was light on details.
Under generally accepted accounting principles, companies reporting related-party transactions must disclose enough information so an outside reader can gain "an understanding of the effects of the transactions on the financial statements."
In its last report, Microsoft said it recorded $24.1 billion of revenue from OpenAI last year, including revenue-sharing payments, along with $6 billion of accounts receivable. It didn't provide prior-period figures or profit data. Investors still lack sufficient information to understand the effects on Microsoft's financial statements or whether the dealings were at arm's length.
OpenAI is a major Azure customer, and more thorough disclosures might have shed light on Azure's true performance. Some of those details might come out anyway if OpenAI files a registration statement to go public.