Shares of Microsoft (MSFT) fell sharply on Thursday, dropping around 5% to $402.37 in early trading, as investors reacted to the company's elevated capital spending outlook and Azure capacity constraints, despite strong cloud growth and an earnings beat.
Microsoft reported adjusted earnings of $4.27 per share on revenue of $82.9 billion for its fiscal third quarter, exceeding analyst expectations of $4.05 per share on $81.4 billion in revenue. The company's Azure cloud division was a standout performer, with revenue growing 40% year-on-year, ahead of estimates of 37.9%. Microsoft also guided for Azure growth of 39% to 40% in the fiscal fourth quarter, above Wall Street expectations of 36.8%.
However, investor sentiment was dampened by a sharp increase in capital expenditure. Microsoft reported quarterly capex of $31.9 billion, up 49% year-on-year, while free cash flow fell 22% to $15.8 billion as the company ramped up investments to support rising demand for cloud and AI services. The company anticipates capital expenditures to exceed $40 billion in the next quarter and forecasts total annual capital spending of approximately $190 billion, significantly higher than Wall Street's estimate of $160 billion.
Internal commentary revealed that Azure's growth would have been even stronger if the company had sufficient data center capacity. Management indicated that capacity shortages are already having a measurable impact on performance, effectively capping how much Azure can expand in the short term. Despite heavy capital spending plans, including a projected infrastructure investment exceeding $100 billion in fiscal 2026, supply constraints are expected to persist well into the next fiscal year.
Adding to market uncertainty, Microsoft recently adjusted its long-standing OpenAI partnership. The revised agreement maintains a revenue-sharing structure through 2030 but removes Microsoft's exclusive rights to resell OpenAI products on Azure, opening the door for OpenAI services to be distributed across multiple cloud platforms, including competitors like Amazon and Google.
Despite the sell-off, several Wall Street analysts raised their price targets on Microsoft. Stifel raised its target to $415 from $392, BMO Capital raised its target to $515 from $505, and Goldman Sachs lifted its target to $610 from $600, maintaining a Buy rating.
