Regulators' Bark Is Still Worse Than Their Bite

Two years ago, Big Tech looked like it was done for...

Folks were getting uncomfortable with the amount of power major tech players had over our data. And Lina Khan – one of the most promising minds of modern antitrust law – made it her mission to rein them in.

Khan made waves in 2017 with an article titled "Amazon's Antitrust Paradox." She called for the breakup of Amazon (AMZN) and for the U.S. to include Big Tech in its antitrust laws.

So when she was appointed chair of the Federal Trade Commission ("FTC") in 2021, everyone expected Khan to come down hard on these companies.

Yet roughly two years later, not much has changed. In fact, it took until last month for the FTC to sue Amazon for potential monopolistic behavior.

So far, investors don't seem to care. Amazon's stock has marginally outperformed the S&P 500 Index since that case went public. Apparently, the market doesn't think the FTC can get the job done.

And that's a fair assumption, considering its lawsuit against Microsoft (MSFT)...

Late last year, FTC regulators went after the tech giant for its landmark acquisition of gaming company Activision Blizzard (ATVI). After months of investigations, the FTC dropped the case. The deal closed earlier this month.

But with the FTC's regulatory shortcomings, other regulators are getting involved... The U.K.'s Competition and Markets Authority ("CMA") recently announced an investigation into Amazon and Microsoft's cloud-computing operations.

We've seen some convincing arguments they have a monopoly on cloud computing. Even so, as we'll explain today, that doesn't guarantee regulators will be able to do anything about it...

Microsoft in particular has a lot hinging on its cloud business...

And while rulings could eventually prove harmful to operations, regulators are unlikely to break ground anytime soon.

The company recognized the growing demand for cloud-computing solutions and launched Azure all the way back in 2010. It didn't take off immediately. But when businesses worldwide started to digitize their processes, cloud-based infrastructure became essential.

By 2015, many businesses started moving to the cloud. Microsoft saw an opportunity to use its existing products as an inroad... pushing its cloud software onto large companies. Most already used Office 365, which made it easier to convince them to try out Azure.

Over the next several years, Azure became Microsoft's best and biggest business.

By 2019, Azure surpassed Microsoft Office as the company's main revenue source – and it never looked back.

The increased focus on Azure has led to a surge in Microsoft's profits. Since 2016, the company's Uniform earnings have more than tripled.

Take a look...

That's an incredible transformation for a company as big as Microsoft. And it's all thanks to Azure.

However, that also means Microsoft is likely nervous about the latest regulatory probe... even though regulators haven't had any luck cracking down on Big Tech.

The U.K.'s CMA is coming after Microsoft's Azure and Amazon's Amazon Web Services because they make up between 60% and 70% of all cloud spending. Both companies also charge fees to transfer your data from their services to a competitor's.

If Microsoft is forced to let more competition enter the market – or if it can no longer charge switching costs – its earnings could start falling. So it will do whatever it can to prevent that.

The good news is that it has time to prepare...

Regulators don't work fast...

And their rate of success isn't all that impressive. As we've covered, the FTC hasn't been able to regulate Big Tech despite years of posturing.

It doesn't seem like U.K. regulators are in a rush with their own investigation, either. Their cloud probe is expected to conclude in April 2025.

That's about a year and a half away... plenty of time for Microsoft to figure out how to protect its business.

Its recent Activision Blizzard acquisition should help it keep growing earnings, even if regulators start chipping away at cloud revenue. And if history is any guide, it doesn't seem like any true regulation is a serious risk.

Things could continue getting better for Microsoft before they get worse. (And that's if they get worse at all.)

While investors should keep an eye on regulatory news, we don't see any real risk that Microsoft's earnings – or its stock – are in danger.

Regards,

Joel Litman
October 24, 2023