Microsoft Corporation (MSFT)

Q1 2026 Results. Cloud Acceleration

We have reported on Microsoft on a number occasions and you can find those reports here, here and here.

The company recently reported its Q1 2026 results.

We will comment on these and note some highlights from the earnings conference call.

Reuters summarised the results as follows:

• Microsoft fiscal Q1 rev grows 18% (y/y), beating analyst expectations, per LSEG data

• GAAP EPS for fiscal Q1 beats analyst expectations, reflecting robust operational performance

Result Drivers

• CLOUD AND AI - Microsoft attributes Q1 growth to strong demand for its cloud and AI services, as noted by CEO Satya Nadella

• INVESTMENTS IN AI - Co continues to increase investments in AI to meet future opportunities, per CEO Satya Nadella

• CLOUD REVENUE - Microsoft Cloud revenue rose 26%, reflecting growing customer demand for its platform, per CFO Amy Hood

Total revenues grew 18.5% (y/y) to a record $77.7bn.

Operating expenses increased by only 5% (y/y) indicating strong cost control.

Operating Profit grew 24.3% (y/y) to $38bn (a quarterly record).

Net Profit increase by 12.5% (y/y). The Net Profit growth is less than one might have expected. This is explained by larger non-operating loss (of $ 3.7bn) and higher tax provision. This non-operating loss of $3.7bn was due to a loss by OpenAI. $4.1bnof this loss was attributed to Microsoft due to its equity holding in OpenAI. The 27% stake is accounted through the equity method.

In terms of segments, Intelligent Cloud was once again the outstanding performer, growing 29.9% (y/y). Within this, Azure’s Cloud business grew 40% (y/y). By way of comparison, Google Cloud Platform also reported an impressive 39% (y/y) growth.

In many ways Azure is the crown jewel of the new Microsoft. We estimate it is already an approximately $75bn annual revenue run rate business and its growing at an impressive 30% (y/y).

Azure grew 39% (y/y) . M365 Consumer Cloud grew 25%.

Operating margins increased year over year to 49% and were ahead of expectations due to stronger than anticipated results in high-margin businesses this quarter.

The cash flow trends follow the positive profit numbers.

Operating cash (OCF) hit a record $45bn while Free Cash Flow (FCF) was a steady $25bn.

Cash flow from operations was $45.1 billion, up 32%, driven by strong cloud billings and collections, partially offset by higher supplier payments.

Free Cash Flow did not grow more due to the increase in investment as OCF – Capital Expenditure = FCF. (See chart below).

Capital expenditure increase d to $19.4bn in the quarter as shown in the blue bar. It is shown as a negative bar as it is a cash outflow for Microsoft.

The key things is that operating cashflow is enough to fund existing and prospective investments

Analysts expect FCF to rise despite the greatly increased capital expenditure. The chart below shows analysts’ expected FCF is expected to rise in the next three years.

Of the FCF of 25.7bn, $5bn was used for share repurchases while dividends account for $6.2bn. An additional $4.3bn was used to repay long-term debt and other financing activities.

This means that about $10bn was (presumably) retained by the company) in the quarter.

This is roughly consistent with the $8bn increase in cash and short-term investments to $102bn in the quarter.

The profitability of the quarter declined a little and this has been a gradual three-year trend. This may reflect the fact that business is gradually becoming more capital intensive.

We define capita intensity as Net Plant and Equipment as a percentage of total assets. As the chart below shows, this has risen from15% in 2017 to 40% in 2025.

Revision of Deal with Open AI

The day before the release the results, Microsoft announced they had concluded their long-standing discussions with Open-AI to revise their partnership agreement.

As part of this, Microsoft now owns a 27% equity stake in OpenAI, valued at $135 billion at the latest $500bn valuation of OpenAI. This agreement potentially paves the way for OpenAI’s IPO

Microsoft also gets an incremental $250 billion of Azure service contracts from OpenAI, although the duration of that contract is not immediately clear, and retains rights to commercialize OpenAI models for two more years, through 2032, and now includes future models, as well. $250bn spending commitment look impressive but we note their 2025 revenues are likely to be $13bn.

OpenAI no longer needs Microsoft’s permission before it inks compute deals with other companies. This is good as Microsoft like others is currently facing a shortage of compute capacity

Press reports suggest that OpenAI will seek a staggering $1tn valuation. Let us see if that is achieved (!). It would be some feat for a company with 2025 revenues of just $13bn and likely losses till 2029.

Highlights from the Earnings conference Call

Huge AI demand

Unlike Meta, Microsoft, Google and Amazon provide compute services including AI to third party (3P) customers. Microsoft say 3P demand is booming

We are seeing increasing demand and diffusion of our AI platform and family of Copilots, which is fuelling our investments across both capital and talent.

Demand is increasing. It is not increasing in just one place. It is increasing across many places. We’re seeing usage increases in products. We are seeing new products launch that are getting increasing usage and increasing usage very quickly.

When people see real value, they actually commit real usage. I sometimes think this is where this cycle needs to be thought through completely, is that when you see these kinds of demand signals, and we know we’re behind, we do need to spend.

The pipeline of business is measured using the Remaining performance Obligation (RPO). Record RPO means good revenue visibility. There was a 51% (y/y) growth in RPO to $398bn and 110%+ (y/y) growth in bookings. The weighted average duration of the RPO is about two years. Therefore, they have good short term revenue visibility.

They are responding to the demand by increasing supply

When it comes to infrastructure, we’re building a planet-scale cloud and an AI factory, maximizing tokens per dollar per watt while supporting the sovereignty needs of customers and countries.

We have the most expansive data center fleet for the AI era, and we are adding capacity at an unprecedented scale.

We will increase our total AI capacity by over 80% this year and roughly double our total data center footprint over the next two years, reflecting the demand signals we see.

The world’s most powerful AI data center, Fairwater in Wisconsin, which will go online next year and scale to 2 gigawatts alone. We have deployed the world’s first large-scale cluster of NVIDIA GB300s.

In the last two quarters, Satya Nadella, the CEO has taken to describing his datacentre investments as fleet; as in a group of naval ships.

We are building a fungible, global fleet that’s being continuously modernized and spans all stages of the AI lifecycle, from pre-training to post-training to synthetic data generation and inference.

It also goes beyond Gen AI workloads to recommendation engines, databases, and streaming. We’re optimizing this fleet across silicon, systems, and software to maximize performance and efficiency.

It’s this combination of fungibility and continuous optimization that allows us to deliver the best ROI and TCO for us and our customers.

They are also responding to increased demand by innovating

We’re innovating rapidly across the family of Copilots, spanning the high-value domains of information work, coding, security, science, health, and consumer.

The OpenAI partnership has been a major driver.

The partnership, which gives Microsoft exclusive access to the models behind ChatGPT, has been key to Azure’s rapid growth in recent quarters and strengthened its challenge to top cloud provider Amazon.com AMZN.O. It is also crucial to Microsoft’s other AI services, such as 365 Copilot for businesses.

On the new agreement with OpenAI

Already, we have roughly 10x our investment. OpenAI has contracted an incremental $250bn of Azure services. Our revenue share, exclusive IP rights, and API exclusivity for Azure continue until AGI or through 2030, and we have extended the model and product IP rights through 2032.

Azure’s outstanding growth.

Azure revenues grew 40% (y/y). It has a comprehensive offering for clients and demand for, and usage of AI, on Azure has exploded.

We also have the most comprehensive digital sovereignty platform. Azure customers in 33 countries are now developing their own cloud and AI capabilities within their borders to meet local data residency requirements.

On top of this infrastructure, we’re building Azure AI Foundry to help customers build their own AI apps and agents. We have 80,000 customers, including 80% of the Fortune 500.

We offer developers and enterprise access to over 11,000 (!) models, more than any other vendor, including, as of this quarter, OpenAI’s GPT-5, as well as xAI’s Grok-4.

When it comes to our first-party models, we’re excited by the performance of our new MAI models for text, voice, and image generation, which debuted among the top in the industry leader boards. We continue to make great progress with our Phi-3 family of SLMs, which now have been downloaded over 60 million times, up 3x YoY.

We are providing everything developers need to design, customize, and manage AI applications and agents at scale. Our new Microsoft Agent Framework helps developers orchestrate multi-agent systems with compliance, observability, and deep

These kinds of real production-scale AI deployments are driving Azure’s overall growth, and once again, this quarter, Azure took share. Now let’s turn to applications and agents we ourselves are building on this platform.

They are seeing huge growth in take up of MSFT’s AI tools

We now have 900mn monthly active users of our AI features across our products.

Our first-party family of Copilots now has surpassed 150 million monthly active users across information work, coding, security, science, health, and consumer.

Just nine months since release, tens of millions of users across the Microsoft 365 customer base are already using chat. Adoption is accelerating rapidly, growing 50% (q/q) , and we continue to see usage intensity increase.

More than 90% of the Fortune 500 now use Microsoft 365 Copilot.

During the quarter, we increased the token throughput for GPT-4-1 and GPT-5, two of the most widely used models, by over 30% per GPU

Copilot is becoming a tool for collective productivity

Beyond individual productivity, Copilot is multiplayer with Teams Mode announced this week.

You can now invite colleagues into a Copilot conversation, and our collaborative agents like Facilitator and Project Manager prep meeting agendas, take notes, capture decisions, and kick off group tasks.

GitHub is the favoured platform for 180mn developers. They have added Copilot to that as well

In coding, GitHub Copilot is the most popular AI pair programmer now with over 26 million users.

For example, tens of thousands of developers at AMD use GitHub Copilot, accepting hundreds of thousands of lines of code suggestions each month and crediting it with saving months of development time.

80% of new developers on GitHub start with Copilot within the first week. Overall, the rise of AI coding agents is driving record usage with over 500 million pull requests merged over the past year.

Capital Expenditure

Large tech companies are on the largest Capex spending spree in the history. The market is worried about the scale of the cash outflow and worries about huge possible write-downs down the line if the anticipated demand does not materialise.

Capital expenditures were $34.9bn, driven by growing demand for our cloud and AI offerings. This quarter, roughly half of our spend was on short-lived assets, primarily GPUs and CPUs, to support increasing Azure platform demand, growing first-party apps and AI solutions, accelerating R&D by our product teams, as well as continued replacement for end-of-life server and networking equipment.

The remaining spend was for long-lived assets that will support monetization for the next 15 years and beyond, including $11.1 billion of finance leases that are primarily for large data center sites. Cash paid for PP&E was $19.4 billion.

We have not been able to verify the $34.9bn figures. It looks too high. Our sources suggest its $19.4bn. 50% of the Capital expenditure is in short lived assets such as chips which may have life of 1 to 3 years. The balance is in datacentres and buildings which many last up to 15 years and earn revenue over the period.

They are making these investments because they are short of compute capacity and they have demand for it today

with $400 billion of RPO that’s sort of short-dated, as we talked about, our needs to continue to build out the infrastructure are very high. That’s for booked business today.

short-lived assets generally are done to match sort of the duration of the contracts or the duration of your expectation of those contracts.

Hopefully, this is helpful for people to realize that these are contracts being signed by customers who intend to use it in relatively short order.

When you think about having revenue and the bookings and coming on the balance sheet and the depreciation of short-lived assets, they’re actually quite matched,

In other words, although depreciation will rise as the assets are short lived, Revenues will also have risen, so net profit trends will not be impacted.

Capital Expenditure is expected to increase

With accelerating demand and a growing RPO balance, we’re increasing our spend on GPUs and CPUs.

Therefore, total spend will increase sequentially, and we now expect the FY26 growth rate to be higher than FY25. As a reminder, there can be quarterly spend variability from cloud infrastructure buildouts and the timing of delivery of finance leases.

We’re investing in infrastructure, AI talent, and product innovation to capture that momentum and expand our leadership position. We remain focused on delivering real value to our customers that results in durable revenue growth for the long term.

Our take on the Capital expenditure concerns

Consider the worlds as seen by Microsoft. They have huge demands for compute capacity bother for their own needs (1^st Party) and for their customers (3^rd Party)

Their order books is $400bn and it is about two years duration on average.

There investing to meet this current demand. There will be an immediate boost to revenues which will offset the increase in deprecation that will also spike as half the new assets are relatively short dated.

They have huge in-house needs for compute capacity and an excess capacity now or in the future can be allocated to their internal needs.

Segment Results

The three key reporting segments are

1. Productivity and Business Processes

2. Intelligent Cloud

3. More Personal Computing.

About 5 years ago they were of roughly equal size in terms of revenues but now the first two are much bigger than the third.

Productivity and Business Processes

In this segment was $33bn and grew 17% (y/y). Operating margins increased three points year over year to 62%,

Intelligent Cloud

In Intelligent Cloud, Revenue was $30.9 billion and grew 28%(y/y)

Within that, Azure and other cloud services, revenue grew 30% (y/y). Operating margins were 43%. Within that, cloud operating margins are about 68%.

More Personal Computing

Revenue was $13.8 billion and grew 4%. Operating margins increased to 30%.

The larger faster growing segments have the highest margins.

Summary

• This was very good set of expectation beating results from MSFT.

• They are seeing strong sales growth especially in Azure Cloud.

• Azure cloud seems to be growing noticeably faster than Amazon AWS which is the market leader.

• The RPO of their business has increased 50% to $400bn.

• They need to invest in compute capacity to meet this demand and for their own requirements.

• Their operating cash flow is more than enough to fund current and potential companies.

• The company continues to grow revenues and profits strongly at a high but gradually declining rate of profitability.

Valuation

At the current share price of $516 we believe the share is at the 10% to 15% premium to its fair value.

We have held the stock for five years and will continue to do so. However, we will not add to the position at the current level.