Microsoft's AI Demand Soars, But Capital Efficiency Concerns Linger

What happened

Microsoft's commercial RPO surged 110% YoY to $625 billion with Azure growing 39% YoY, underscoring robust AI-driven demand as highlighted in a recent article. However, the DeepValue report cautions that this growth is accompanied by escalating AI capex, which has compressed Microsoft Cloud gross margin to 67% and raised questions about returns. Significant risks include about 45% backlog concentration in OpenAI and low Copilot penetration, limiting near-term monetization potential. Market sentiment has shifted from pure growth celebration to a focus on capital efficiency, with investors wary of margin durability amid high spending. Despite strong top-line metrics, the stock's trajectory hinges on Azure sustaining growth while margins recover from AI investment drag.

Implication

The surge in RPO and Azure growth confirms high demand visibility but does not alleviate concerns over margin pressure from record capex, which could cap near-term stock appreciation. Investors must watch for Azure growth to meet or exceed 35% while cloud gross margin stabilizes or rebounds from 67% to validate the AI investment thesis. Any deviation, such as Azure growth dipping below 30% with capex still rising, risks triggering a re-rating toward the bear case value of $360. Copilot's low adoption and OpenAI concentration add layers of risk that could undermine backlog conversion and cloud profitability. Until clear signs of margin normalization emerge, patience is warranted, with entry points better aligned around $360 to $475 for balanced risk-reward.

Thesis delta

The new article reinforces the growth narrative but does not address the key risks of capital efficiency and margin pressure outlined in the master report. Therefore, the thesis remains unchanged: a 'WAIT' rating is appropriate until Azure growth sustains at or above 35% and cloud gross margin recovers to at least 69%. No shift in the investment call is warranted, as the data confirms demand but not profitability improvements.