Microsoft presented solid earnings after the bell on Thursday, January 30th. We dove a bit deeper in to the numbers and the full transcript.
Some highlights:
Continued strength in Microsoft Cloud, which surpassed $40 billion in revenue for the first time, up 21% year-over-year.
AI business has surpassed an annual revenue run rate of $13 billion, up 175% year-over-year.
Commercial bookings increased 67% and 75% in constant currency and were significantly ahead of expectations (more on that later).
Strength across the core annuity sales motions with growth in the number of 100-million-dollar-plus contracts for both Azure and Microsoft 365.
Microsoft Cloud gross margin percentage was 70%, in line with expectations.
Revenue from Productivity and Business Processes was $29.4 billion and grew 13% in constant currency. M365 commercial cloud revenue increased 15% in constant currency, slightly ahead of expectations due to better-than-expected performance in E5 and M365 Copilot.
Intelligent Cloud segment revenue was $25.5 billion and grew 19%.
So why did the stock go down 4% in trading before the market opened on Friday?
At Wingspan we see a couple of reasons:
Azure growth rate stalling.
Financial analysts mainly look at the recurring revenue at Microsoft and within that specifically how well Azure growth is doing. Azure revenue came at the low end of expectations with 31% growth. This compares to 33% growth in Q1 and 33% growth in Q2 of last year. Azure growth included 13 points from AI services, which grew 157% year over year and was ahead of expectations with demand higher than available capacity. Growth in non-AI services was slightly lower than expected due to go-to-market execution challenges, particularly with customers that Microsoft primarily reaches through scale motions, balancing driving near-term non-AI consumption with AI growth.
Datacenter spend.
Over the last couple of months there has been increasing scrutiny on the enormous amounts spend by hyperscalers on building out datacenter infrastructure for AI with no clarity of the immediate payback. Both Satya Nadella went out of their way to state that Microsoft was going to balance spending a bit more and introduced us to terms as ´fungible fleet´ when talking about datacenter investments.
In FY26, we expect to continue investing against strong demand signals including customer contracted backlog we need to deliver against across the entirety of our Microsoft Cloud. However, the growth rate will be lower than FY25 and the mix of spend will begin to shift back to short-lived assets which are more correlated to revenue growth. As a reminder, our long-lived infrastructure investments are fungible, enabling us to remain agile as we meet customer demand globally across our Microsoft Cloud including AI workloads.
Microsoft Cloud gross margin percentage was 70%, in line with expectations, and decreased 2 points year-over-year driven by scaling AI infrastructure.
OpenAI relationship, Stargate and Deepseek.
Microsoft and OpenAI have a revenue sharing deal with all OpenAI running on Azure. However, OpenAI, on the one hand, cannot get enough capacity for its big plans. Hence Stargate, where Microsoft plays a secondary role, and Microsoft is opening up Azure to all sorts of LLM´s to be less dependent on OpenAI.
To put the OpenAI impact on Microsoft in perspective there are two important datapoints in the earnings call. First the commercial bookings growth. In Q2 last year it was 9% Year on Year. This quarter it was a staggering 75% YoY, or in absolute numbers $39 billion sequentially! And Amy Hood admitted that the main driver for this was the Azure commitments that OpenAI has made. Another segment where OpenAI has a large impact on Microsoft is Search and news advertising. Revenue ex-TAC increased 21% and 20% in constant currency, ahead of expectations driven by usage from a third-party partnership. We can only assume that this third-party partnership is OpenAI.
Deepseek has proven that there are a lot of efficiency gains possible for creating and training LLM´s and has made a wider non-technical audience worried about the spending patterns of US based hyperscalers. In our view, lower cost for training and inference will only lead to more growth and adoption of AI as prices will go down.
Q3 outlook
Q3 outlook was like the Q2 numbers wit Azure estimated at 31 to 32% growth, so pretty flat. Microsoft Cloud gross margin percentage estimated at 69%, down year-over-year driven by the impact of scaling AI infrastructure. So no upbeat projections which did not help the short term stock price.
Conclusion
Microsoft is performing very well and is growing its bottom line even quicker that its top line, which is growing double digits. There is still however a lot of work to do. As stated, Microsoft´s cloud business reached 40B$ this quarter, but this is still only 57% of its overall revenue.
There are a couple of interesting datapoints. Microsoft overperforming in AI based Azure revenue (and limited by availability, so the revenue could be even higher if not for supply constraints) and Microsoft clearly underperforming on core Azure consumption in the SMB market versus their expectations.
Microsoft announcing openly that they have execution issues and announcing an organizational change separating the SMB organization with a separate partner organization is big, they don’t tend to do this in the middle of the year.
Over 60% of Microsoft’s revenue comes from enterprise. Microsoft has been shifting resources more and more towards its enterprise organization over the last years and is now seeing the results of that. We will go deeper into this announcement in a separate blog post but at Wingspan we think this is good news for MSP´s and ISV´s focussing on the SMB market.
About Wingspan Equity
Wingspan Equity is a Private Equity secondary-investment and advisory firm dedicated to accelerating growth and creating lasting value for technology organizations held by private equity. We go beyond capital, offering:
• Operational expertise: Proprietary mechanisms and accelerators to drive performance.
• Alignment of goals: A co-investment model that ensures all parties focus on shared outcomes.
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