To The Moon

Microsoft Earnings Review: The Much-Criticized CapEx Surge Is Merely a Catch-Up for Last Year's Slowdown

$Microsoft(MSFT)$ ' s latest earnings report showed Azure cloud revenue growth of 39%, which actually exceeds $Alphabet(GOOG)$   Cloud's 33.5% growth. Yet after hours, Microsoft’s stock fell more than 3%, while Google's rose more than 7%. There are both reasonable and unreasonable aspects to this reaction.

The unreasonable part:

The market blamed Microsoft's 72% capex growth for beating expectations, but Google’s capex growth was even higher at 83.4%.

In terms of revenue backlog growth, Microsoft's momentum is not weaker than Google's. Google's remaining obligations rose 43% by to $155 billion, while Microsoft's increased by 51% year over year, and the value of new contracts signed in the quarter surged by more than 110%. This suggests Azure revenue could continue to accelerate as that backlog is recognized.

Possible reasons (or the reasonable aspect of the price move):

First, Microsoft's valuation (35–40x) is indeed higher than Google's (25–30x), so the market's expectations for Microsoft are naturally loftier. Also, the AI models empowering Google Cloud are its own in-house large models.

Microsoft and Google report on different fiscal calendars. Microsoft released FY2026 Q1 earnings this time, and the market may linearly extrapolate that quarter's capex growth for all of 2026. Moreover, Microsoft's capex slowed in FY2025, and the accelerated spending in FY2026 is essentially catching up for the prior year.

Google reported FY2025 Q3 earnings this time, and management indicated that capex growth will slow to 8% in 2026. This creates the impression that Google's cash burn will step down in 2026.

Even considering these factors, it does not support the conclusion of “Google advances, Microsoft retreats.” Based on overall cloud scale and revenue backlog, Microsoft is still likely to remain one of the biggest beneficiaries of cloud computing in the AI era.

The following are the details of this earnings report.

Key Financial Indicators

- Revenue: Third-quarter revenue was $77.67 billion, up about 18% year over year, versus analysts' expectation of $75.55 billion. Second-quarter year-over-year growth was 18%.

- EPS: Third-quarter diluted EPS was $3.72, up about 13% year over year, versus analysts' expectation of $3.66. Second-quarter year-over-year growth was 24%. OpenAI's widening losses, as Microsoft is a shareholder, led to further investment losses that weighed on overall earnings.

- Operating income: Third-quarter operating income was $37.96 billion, up about 24% year over year, versus analysts' expectation of $35.1 billion. Second-quarter year-over-year growth was 23%.

- Capital expenditures: Including assets obtained via finance leases, third-quarter total capital expenditures were $34.9 billion, up 74.5% year over year, versus analysts' expectation of $30.06 billion. Second-quarter growth was 27%.

Q3 Business Segment Breakdown

- Intelligent Cloud: Including Azure public cloud, Windows Server, Nuance speech-recognition software, and GitHub. Q3 revenue was $30.9 billion, up about 28% year over year, versus analysts' expectation of $30.18 billion. Q2 year-over-year growth was 26%.

- Productivity and Business Processes: Including Office software such as Microsoft 365 Copilot AI tools. Q3 revenue was $33.02 billion, up about 16.6% year over year, versus analysts' expectation of $32.29 billion. Q2 year-over-year growth was 16%.

- More Personal Computing: Including Windows OS, Surface hardware, Xbox consoles, and Activision Blizzard. Q3 revenue was $13.8 billion, up 4% year over year, versus analysts' expectation of $12.88 billion. Q2 year-over-year growth was 9%.

Impact of OpenAI Investment on Q3 Net Income Was Nearly $3.1 billion

The earnings report shows that, on a GAAP basis, Microsoft's Q3 net income was dragged by $3.086 billion due to its investment in OpenAI, far above $523 million a year earlier. The impact on EPS was $0.41 per share, also well above $0.07 per share a year earlier. The investment in and partnership with OpenAI grant Microsoft rights to use OpenAI's products and models, which has been crucial to Azure's rapid growth in recent quarters, strengthening Microsoft Cloud's ability to challenge Amazon Web Services (AWS).

The day before the earnings release, on Tuesday of this week, OpenAI and Microsoft announced a major agreement. Microsoft holds 27% equity in the reorganized OpenAI for‑profit entity and will extend the intellectual property (IP) license for OpenAI's models and products through 2032. OpenAI committed to pay $250 billion in leasing fees to Azure over the coming period, securing long‑term, stable revenue for Microsoft.

Summary

Overall, the earnings report meets expectations in terms of each segment's revenue. However, the market is concerned about the surge in its CapEx.

~Valuation:

Microsoft's current P/E ratio is above 39x, placing it in the 99th percentile over the past five years.

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