Microsoft's AI Backlog Growth Confronts Valuation and Capex Challenges

What happened

A recent Seeking Alpha article highlights Microsoft's AI-driven growth, citing a 112% year-over-year surge in commercial bookings and a $392 billion remaining performance obligation backlog, with Azure revenue accelerating to 40% in Q1 FY2026. However, DeepValue's master report reveals that despite strong fundamentals, Microsoft's stock trades at a 272% premium to a conservative DCF valuation of ~$131 per share, indicating significant overvaluation. The report notes pressured cloud gross margins, which fell to 69% in FY25 due to heavy AI and datacenter capital expenditures, alongside over $180 billion in lease commitments that heighten financial risk. Regulatory uncertainties, such as EU antitrust actions on Teams bundling, and a less exclusive OpenAI partnership add further downside potential that could impair future earnings. While the AI utility thesis is compelling, the current valuation leaves little margin of safety, necessitating a cautious stance despite the optimistic growth projections.

Implication

The surge in commercial bookings and RPO backlog signals robust demand for Microsoft's AI services, particularly Azure and Copilot, supporting long-term growth prospects. However, the stock's elevated P/E ratio of ~34.6x and premium over intrinsic value suggest that much of this growth is already priced in, limiting near-term upside. Heavy capital expenditures on AI infrastructure are compressing cloud gross margins, which could hinder profitability if not offset by sufficient pricing power or adoption. Regulatory risks, including potential fines or unbundling mandates, and uncertainties in the OpenAI partnership further cloud the investment case by adding operational and strategic headwinds. Therefore, while the AI-driven growth story is intact, investors should adopt a wait-and-see approach, monitoring margin trends and regulatory developments before committing capital at current levels.

Thesis delta

The new article reinforces the bullish AI growth thesis by highlighting accelerating Azure revenue and a massive backlog, but it does not address the critical valuation and margin concerns detailed in the DeepValue report. Consequently, the overall investment thesis remains unchanged, advocating for a 'WAIT' stance due to the thin margin of safety and persistent risks that could undermine future returns.