Azure Growth 40%, AI Revenue 37 Billion: Why Did Microsoft Shares Fall Instead of Rise?

For the quarter ended March 31, Microsoft reported revenue of $82.886 billion, up 18.3% year-over-year, surpassing market expectations of $81.39 billion; net income reached $31.778 billion, a 23.1% increase year-over-year, with diluted earnings per share of $4.27, beating expectations by approximately 5%. Total Microsoft Cloud revenue was $54.5 billion, representing a 29% year-over-year increase.

[Microsoft Third-Quarter Results, Source: Microsoft Official Earnings Report]

In the earnings report, the closely watched revenue growth for Azure and other cloud services hit 40%, up from 39% in the previous quarter and slightly exceeding Wall Street expectations. Analysts surveyed by StreetAccount and CNBC had previously forecasted growth of 39.3% and 38.8%, respectively.

Paid seats for Copilot for Business surpassed 20 million, an increase of 5 million from the 15 million reported in January. Based on a monthly fee of $30 per seat, every 1 million new Copilot seats is estimated to contribute approximately $250 million in incremental annual recurring revenue (ARR).

[Microsoft Product and Service Revenue, Source: Microsoft Official Earnings Report]

Microsoft's AI business reached an annualized revenue of $37 billion, up 123% year-over-year. This scale is equivalent to twice that of Adobe ( ADBE )'s annual revenue (Adobe's total revenue for fiscal year 2025 is approximately $21 billion).

Wedbush analyst Dan Ives reiterated a "Buy" rating and a $600 price target. He believes the $37 billion annualized revenue is a watershed moment, proving that Microsoft can monetize AI at scale. Capital expenditures are merely upfront costs, and returns will be concentrated in 2027-2028.

Skeptics point out that the gross margin for AI services is only about 60%, lower than the roughly 80% margin for traditional software. CFO Amy Hood acknowledged during the earnings call that data center depreciation is compressing gross margins, which will remain under pressure for the next several quarters.

The essence of this disagreement is the time horizon: bulls are betting on a free cash flow explosion in 2028, while bears are focused on a cash flow decline in 2026. Success will depend on how investors judge the AI return cycle.

Behind the stellar figures of 40% Azure growth and $37 billion in AI revenue, the market remains laser-focused on another set of numbers: capital expenditures.

Capital expenditures for the quarter were $31.9 billion, up 49% year-over-year but below the $34.9 billion analysts expected; this was initially interpreted by the market as a positive, leading to a brief rally in after-hours trading.

However, CFO Amy Hood subsequently raised the full-year fiscal 2026 capital expenditure forecast to $190 billion, far exceeding the approximately $154.6 billion previously expected by analysts.

This upward revision has already begun to squeeze current financial metrics: free cash flow for the quarter was $15.8 billion, a 22% decline from $20.3 billion a year earlier, and gross margin hit 67.6%, its lowest since 2022.

Bernstein analyst Mark Moerdler believes that market sensitivity to capital expenditure has become excessive. He stated that Microsoft's CapEx is not "burning cash" but rather an upfront investment in capacity for the next three years. The $190 billion, which averages out to over $63 billion annually, basically matches the current revenue scale of the cloud and AI businesses. Meanwhile, Amazon ( AMZN ), Google ( GOOGL) have even higher capital expenditure intensity and account for a larger share of cloud revenue, yet both stocks rose by more than 5% after hours.

However, dissenting voices remain. Stifel analyst Brad Reback warned that the continuous decline in free cash flow is a red flag. If free cash flow does not return to growth by fiscal year 2027, Microsoft's ability to fund dividends and buybacks will be restricted—a core risk that long-term investors should guard against. If free cash flow remains below $20 billion by then, the valuation could face correction pressure of 10%-15%.

Google parent Alphabet's cloud business reported a 36% operating margin this quarter, while Microsoft Cloud's gross margin was 66%. However, the reporting metrics differ: the former is operating margin, while the latter is gross margin. When normalized to operating margin, Microsoft's overall operating margin this quarter was approximately 46.3%, showing no significant gap from Alphabet's 36%.

JPMorgan Chase ( JPM) analyst Mark Murphy noted that Alphabet's net profit surged 81%, partly due to a low base from legal fines in the prior-year period rather than being solely cloud-driven. He also stated that Microsoft's annualized AI revenue has reached $37 billion, surpassing Google Cloud's AI-related revenue; as they are in different growth stages, a direct comparison of "efficiency" is unfair.

By contrast, Microsoft's AI commercialization path is clearer, with Copilot enterprise subscriptions contributing steady incremental ARR, GitHub Copilot serving 140,000 organizations, and Azure AI services emerging as a new growth engine.

According to data from TradingKey, as of April 29 Eastern Time, among the 60 analysts covering Microsoft, the majority have assigned a "Buy" rating, with an average target price of $578.51, implying an upside of approximately 36.24% relative to the current share price.

[Source: Refinitiv, TradingKey]

Overall, Microsoft's earnings report is not perfect, but it is certainly not a crisis. While capital expenditure pressures are real and the decline in free cash flow warrants vigilance, key indicators such as AI revenue scale, Azure's growth rate, and Copilot penetration all point toward a healthy growth trajectory.

The market's short-term reaction may have amplified anxiety over capital expenditures while underestimating the certainty of AI monetization. For long-term investors, this earnings report may provide a "Buy" window, but it remains important to monitor whether free cash flow can rebound over the next two quarters and whether Azure's growth rate remains stable above 35%.

This content was translated using AI and reviewed for clarity. It is for informational purposes only.