Under the Spotlight: Microsoft ($MSFT)

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Microsoft ($MSFT) doesn’t often do drama. It’s the steady, suit-and-tie giant of tech – the one that quietly sits behind your emails, your meetings, your spreadsheets, and, increasingly, the AI tools you’re being told will ‘transform productivity’.

So when Microsoft shares plunged 10% in a day following its latest earnings update, despite beating expectations, investors were sending a pretty blunt message: the AI spend is impressive, but where’s the payoff?

The tech giant is investing tens of billions into data centres, chips and cloud infrastructure to power the next era of AI. And it’s making a very big bet that it can turn that infrastructure into higher-margin software revenue through Copilot.

Microsoft’s quarter, in headline terms, was strong. Revenue came in at US$81.3B and adjusted earnings hit US$4.14 per share, both above forecasts. The problem is that markets aren’t just grading Microsoft on ‘good.’ They’re grading it on whether AI is starting to show up in the numbers.

The AI play

When Microsoft partnered with OpenAI back in 2019, the market hadn’t yet caught on to how pivotal AI would be to the tech giant’s growth story.

Today, Microsoft’s AI strategy is two-fold. Its Azure cloud platform is the infrastructure layer, running everything from OpenAI’s models to enterprise AI workloads, which is why investors increasingly treat it as the clearest read on AI demand. Its Intelligent Cloud segment, which includes Azure, accounts for around 38% of Microsoft’s revenue today.

The other closely watched AI play is Copilot, the product meant to turn AI into recurring, high-margin software revenue. Its advantage is distribution. Copilot is sold as an add-on to Microsoft 365, for up to US$30 per user per month.

That’s why the market latched onto one disclosure on the earnings call: Microsoft 365 Copilot now has 15M paying users. That’s a big number – until you hear the denominator. Microsoft has said it has around 450M paid Microsoft 365 seats, which means Copilot penetration is still only a small slice of the base, at roughly 3%. 

And that’s the investor anxiety in one line: Copilot is adopted, but not yet adopted at the scale that changes Microsoft’s growth profile.

That concern is compounded by Microsoft’s contract backlog. The company has US$625B in upcoming contracted projects, but has disclosed that roughly 45% of it is tied to OpenAI, increasing investor focus on customer concentration risk. 

Those figures have only faced fresh new scrutiny after the Wall Street Journal reported Nvidia ($NVDA) might not go through with its US$100B investment into OpenAI, part of a circular deal announced last September that helped fuel AI bubble fears.

The Azure dilemma

Azure is still growing at a rate most companies would dream about. But the market is laser-focused on the direction.

The numbers suggest Azure growth is slowing, with projections of 37–38% growth next quarter, down from 38% this quarter and 39% last quarter. That might not sound like a big deal, but in Big Tech, a slowing growth rate can matter more than the headline number. It shifts the story from ‘AI is accelerating demand’ to ‘AI is a very expensive build-out that’s not accelerating fast enough’.

This is where Microsoft’s capex becomes the centre of gravity. Microsoft’s capital spending for the quarter was US$37.5B, up a huge 66% year-on-year, with a large share going toward AI chips and compute. Microsoft has also flagged ongoing capacity constraints – demand exceeding supply in parts of Azure – which sounds good, but also highlights just how capital-intensive this race has become.

The worry investors keep circling is a classic tech-world problem: the spending is front-loaded (build the data centres now), the revenue is back-loaded (monetise AI use over years), and markets are not in a patient mood.

Office goals

While Microsoft’s share price rally over the last 12 months is firmly tied to the firm’s investment in AI, its product suite is a diversified, cash-generating machine.

At its core, Microsoft is still powered by subscription software. Microsoft 365, which includes Office, Teams and Outlook, is the money engine of the business. Companies pay per user, per month, often under multi-year contracts, and once those tools are embedded, switching is costly and disruptive. 

That stickiness shows up clearly in the numbers. In the latest quarter, Microsoft’s Productivity and Business Processes segment delivered 14% growth and US$34.1B in revenue.

That was underpinned by higher average revenue per user and continued seat expansion across commercial customers. This is the part of the business that throws off predictable cash and gives Microsoft the confidence to invest aggressively elsewhere.

That durability doesn’t remove competitive pressure, especially in cloud infrastructure from Amazon Web Services ($AMZN) and Google Cloud ($GOOGL).

Valuation check

Microsoft is rarely ‘cheap’. Investors typically pay a premium for durability, cash flows, and its position in enterprise tech. That said, the latest analyst views suggest there might be an opportunity.

Based on 17 analyst ratings published on Stake Black, $MSFT’s average price target is US$590 – about 50% above its current price – with 16 rating it a ‘Buy’.

Goldman Sachs has maintained a Buy rating with a US$600 price target, pinning its thesis on the success of first-party applications like Copilot over Azure. Morningstar also sees Microsoft as moderately undervalued against its US$600 fair value estimate, while flagging Azure as the most critical revenue driver over the next decade.

On the other hand, Zacks Research notes Microsoft’s valuation already reflects much of its growth profile, viewing the stock as more of a neutral or market-perform setup over the next 6–12 months, rather than a screaming bargain.

That’s all to say the market is still willing to pay up for Microsoft, but it wants cleaner evidence that AI is additive, not just expensive.

Buy or sell?

Microsoft’s AI strategy is logical: own the infrastructure (Azure), sell the tools (Copilot), and let its distribution do the heavy lifting across the enterprise world.

The issue is timing. Investors are no longer impressed by AI spend. They want to see: Copilot adoption scale materially beyond early pockets, Azure demand broaden beyond a handful of mega customers and capex translate into durable, profitable growth.

The bull case is that Microsoft is building the rails for AI’s next decade, and short-term impatience is creating long-term opportunity.

The bear view is that Microsoft is morphing from an asset-light software business into a more capital-intensive infrastructure operator, and that can compress returns if AI monetisation doesn’t catch up fast enough.

Either way, Microsoft is still one of the cleanest ‘AI + enterprise’ plays in the market. The only question now is whether Copilot becomes the iPhone moment for workplace software… or just another feature people like, but don’t pay up for.

This is not financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. The author of this article and other employees of Stakeshop Pty Ltd may hold positions or have financial interests in the company (or companies) discussed above. As always, do your own research and consider seeking financial, legal and taxation advice before investing.