Review|MSFT 2Q26: The Market is Only Beginning to Reward Better ROI

Results

1. Copilot
   1. In our previous Preview, we noted that positive channel feedback suggested Copilot seat growth and enterprise deployments could exceed expectations.
      1. Microsoft disclosed more than 30 million paid M365 Copilot seats this quarter, with roughly 10 million net additions versus approximately 5 million in the prior quarter. The clear acceleration was consistent with the positive trend from our channel checks. E7 has also reached several million seats since launch.
      2. M365 Commercial Cloud revenue grew 14% YoY cc, slightly above consensus and at the high end of company guidance, but below some higher market expectations. Several large customers expanded Copilot deployments and placed initial E7 orders only near fiscal year-end, while Cowork did not reach GA until June, limiting their contribution to the quarter. In addition, enterprise-wide deployments typically come with higher discounts, while more base-seat additions came from lower-ARPU SMB and frontline-worker SKUs. As a result, seat growth has not yet fully translated into quarterly ARPU or revenue.
      3. Management expects M365 Commercial Cloud revenue growth to accelerate progressively through FY27 as contributions from Copilot, E7 and Cowork flow through.
   2. Copilot’s monetization model is expanding from per-seat pricing to a combination of seats and usage.
      1. E7 includes Microsoft 365 Copilot and Agent 365 in the seat-based subscription. Agentic features such as Cowork are billed separately through Copilot Credits, while GitHub Copilot has also introduced usage-based billing.
      2. After GitHub Copilot introduced usage-based billing, consumption revenue ramped quickly. GitHub Copilot revenue grew more than 60% QoQ this quarter, while margins improved through the quarter.
2. Azure
   1. FY26Q4 Azure grew 43% YoY cc, above our estimate, 3.5 ppts above the midpoint of guidance and 4 ppts faster than the prior quarter.
   2. Management expects Azure growth in 1H FY27 to exceed growth in 2H FY26. At constant currency, FY27Q1 Azure growth is expected to accelerate further to approximately 45%, above our 42.7% estimate.
   3. Management attributed the Azure upside this quarter mainly to improved CPU and GPU fleet efficiency, better delivery processes that brought new capacity online earlier, and stronger-than-expected consumption revenue following the introduction of usage-based billing for GitHub Copilot. Capacity allocation between 1P and 3P did not change.
   4. The improved pace of capacity activation was consistent with the channel checks in our Preview. We found no material delays in major data center projects scheduled to come online this quarter or over the next several quarters.
   5. At the same time, new Azure demand has become more diversified. Commercial RPO reached $678 billion, up 84% YoY and still up 25% excluding OpenAI. The roughly $51 billion QoQ increase this quarter came entirely from commitments by customers other than frontier-model companies, indicating that incremental RPO is being driven by a broader customer base rather than AI labs such as OpenAI.
3. CapEx
   1. Beginning in FY27, Microsoft will extend the estimated useful lives of data centers and office buildings from 15 years to 25 years. As a result, some data center leases that would previously have been classified as finance leases will be treated as operating leases, reducing CY2026 CapEx guidance including finance leases from approximately $190 billion to $175 billion.
   2. Because 1H CY26 has already ended, the full approximately $15 billion reduction in full-year guidance is reflected in the 2H CY26 CapEx presentation. The adjustment is mainly driven by lease classification and financial-statement presentation and does not imply any reduction in underlying data center construction or server procurement. On the previous accounting basis, the underlying CY2026 investment plan remains unchanged at approximately $190 billion.
   3. Management also expects FY27 CapEx to grow YoY while full-year free cash flow remains positive. This is effectively the only indication management provided on next year’s CapEx. We estimate MSFT’s FY27 EBITDA at close to $250 billion and interpret the guidance as implying CapEx of approximately $240-250 billion.
   4. Based on early supply-chain feedback, we remain constructive on Microsoft’s CapEx outlook for next year.

Q&A

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