Microsoft (MSFT) Stock: Why Shares Dropped Despite Beating Earnings

TLDR

• Microsoft reported Q1 earnings of $3.72 per share on revenue of $77.7 billion, beating analyst expectations of $3.68 per share and $75.5 billion in revenue.
• Commercial cloud revenue hit $49.1 billion, up 26% year over year, while Azure revenue grew 40%.
• Capital expenditures jumped 74% to $34.9 billion, with roughly half spent on GPUs and CPUs for Azure infrastructure.
• Microsoft’s net income took a $3.1 billion hit from its OpenAI investment, which now totals $13 billion with $11.6 billion funded through September.
• Under a new deal, Microsoft holds 27% of OpenAI valued at $135 billion, loses first refusal rights for compute services, but secured a $250 billion Azure contract commitment.

Microsoft reported first quarter earnings after the bell on Wednesday that topped analyst expectations. Revenue hit $77.7 billion while earnings per share came in at $3.72.

Microsoft Corporation, MSFT

Analysts had expected earnings of $3.68 per share on revenue of $75.5 billion. The company posted earnings of $3.30 per share and $65.6 billion in revenue during the same quarter last year.

The stock fell more than 2% despite the beat.

Commercial cloud revenue reached $49.1 billion, up 26% year over year. Analysts had expected $48.6 billion. Azure revenue grew 40% during the quarter.

Microsoft’s Intelligent Cloud segment, which includes Azure, generated $30.9 billion in revenue. Wall Street was looking for $30.2 billion.

But investors focused on spending. Capital expenditures increased 74% year over year to $34.9 billion. Roughly half of that went toward GPUs and CPUs to meet demand for Azure.

The results came as Azure services recovered from an outage on Wednesday that impacted businesses worldwide. Amazon’s AWS experienced a similar outage the previous week.

The OpenAI Factor

Microsoft’s net income took a $3.1 billion hit during the quarter. The company attributed this to an “equity method investment” in OpenAI.

The accounting adjustment resulted in a 41-cent decline in earnings per share. Net income still rose to $27.7 billion from $24.67 billion a year ago.

Microsoft has invested $13 billion total in OpenAI. As of the end of September, $11.6 billion of that amount had been funded.

The timing coincided with OpenAI completing its recapitalization. The AI company restructured as a nonprofit with a controlling stake in its for-profit business.

The nonprofit, now called the OpenAI Foundation, holds an equity stake worth about $130 billion. Current and former employees plus investors hold 47% of the for-profit entity.

New Deal Terms

Microsoft now holds 27% of OpenAI’s public benefit corporation valued at $135 billion. The stake is calculated on an as-converted diluted basis.

The new agreement changed key terms of the partnership. Microsoft lost its first right of refusal as a compute provider for OpenAI.

But OpenAI committed to purchase $250 billion in Azure services. CEO Satya Nadella called the relationship “one of the most successful partnerships and investments our industry has even seen.”

The companies have been partners for over half a decade, starting in 2019. Their collaboration predates the launch of ChatGPT in late 2022.

Microsoft has relied on OpenAI’s models to power AI features across its products. But the companies increasingly compete in parts of the AI market.

Last year Microsoft added OpenAI to its list of competitors in its annual report. The filing identified OpenAI as a rival in AI offerings, search, and news advertising.

OpenAI previously served as Microsoft’s sole cloud services provider. The two companies agreed to let OpenAI use other cloud providers for additional capacity.

That allowed OpenAI to partner with Oracle to build out Stargate Project data centers. Microsoft retained first right of refusal under the old terms.

In August, Microsoft began testing a homegrown AI model. The model could lead to enhancements for its Copilot assistant for consumers.

OpenAI announced it completed the recapitalization on Tuesday. The OpenAI Foundation now holds a 26% stake in the for-profit arm.

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