00:00We had the biggest upside in Azure growth we've seen in four quarters and actually CapEx guide was lowered for
00:08calendar 26.
00:09I don't think anyone expected that.
00:11There's been a lot of sensitivity around the direction of CapEx and for Microsoft to be able to deliver such
00:18good growth acceleration with CapEx in check was a great surprise to the market.
00:22And I think this stock has been under owned and these results are attracting money flows back in.
00:27Derek, in your note, you point out that Microsoft's been successful extending the life of its data centers.
00:32How has it been able to do that and what does that mean for the company's prospects going forward?
00:36They did make a reclassification from 15 years to 25 years and that is going to extend the payment terms
00:43over a longer period of time.
00:45That does help the cash flow.
00:47Now that they've been in the data center business for about 15 years, they've got more operating history.
00:53They have the ability to show there's longer useful life.
00:56So that certainly we've seen that with changing useful life and chips moving from four years to five years to
01:02six years.
01:02And that's spread out the amortization of CapEx, equipment CapEx and COGS.
01:07Now we're seeing that more on the land and buildings.
01:10And, you know, it's certainly helpful for the financial statements and investors.
01:15So even so, these companies, Microsoft included, are spending a lot, even if it's not as large as perhaps was
01:21initially feared.
01:22And to doing so, they're often topping these debt markets.
01:26I mean, you cover Oracle as well and the market has been pushing back against the spending they're doing for
01:30some time.
01:30But you're starting to see it in companies like Microsoft too.
01:33Derek, does it make their life more difficult if the cost of capital continues to creep up?
01:39I mean, I think that's what was weighing on Microsoft stock recently.
01:43Last quarter, there was a very different scenario.
01:46They raised CapEx in a big way.
01:49We took down our free cash flow numbers.
01:51And actually, in fiscal 28, we started modeling free cash flow burn.
01:56That started bringing up questions as to will Microsoft need to go to the debt markets, to the equity markets,
02:03to raise more money, to fund the dividends still that they've got to fund.
02:06And with last night's print, I think that some of those concerns are definitely being put to rest.
02:13I mean, our free cash flow for this year went from $4 billion to $35 billion.
02:16We no longer have them going into free cash flow burn territory.
02:20I think that's taken the risk of having to go to the debt markets really off the table.
02:25So hence why we see the stock getting so rewarded.
02:29Microsoft co-pilot, 30 million seats.
02:32What can we take away from that?
02:34What can other companies take away from that?
02:35About the way that they've kind of found a way to make the use of that product sticky for so
02:39many of its consumers?
02:41Yeah, that's it.
02:42When we look at the application space, they're doing probably the best in terms of monetizing AI through software applications.
02:51That 30 million number was fantastic.
02:5310 million sub-ads.
02:55That was more than double than 5 million last quarter.
02:58The quarter before that, I think, was only 1 or 2 million.
03:01I mean, there's clearly big inflection in momentum.
03:04I think they've come a long way in improving the product over the last 12 to 18 months.
03:10They talked about their user satisfaction scores are up 2x over the last three quarters and at all-time highs.
03:18I think they've really improved the product, and they're starting to see that pay off.
03:23It's only 6.5% of subscribers that have co-pilot today.
03:27We're expecting that they get to 30% by the end of 2030.
03:31So there's a long way to go, and it drives a nice ARPU uplift.
03:35It's a $30 price point for co-pilot.
03:37E5 is a $60 price point.
03:40So it's a 50% uplift if they're cross-selling co-pilot.
03:43And, again, momentum is really starting to inflect.
03:46With all this integration of AI, Derek, as you were talking, I was thinking about the story that FT had
03:52out yesterday talking about Amazon,
03:54that they've found all of these cases within the company where AI spending has just gotten out of control
04:00because employees were doing different tasks and not tracking tokens.
04:03You note in your coverage of Microsoft that they are looking for cheaper models,
04:08that they've started to integrate into open-source models.
04:11Is Microsoft ahead of the curve here when it comes to big tech spending on their AI products?
04:18Yeah, I mean, Microsoft has brought out some of their own models called My,
04:22and I think those have been really focused on cost-efficient usage of tokens.
04:27They are also embracing open-source models like DeepSeq, open-weight models as well.
04:34And they're in the position to be able to, you know, bring in different models,
04:38actually become a model router within their infrastructure so they can let enterprises choose
04:44or they can automate based on various workloads what's the right model
04:48and what's the most cost-efficient use of all this AI.
04:51They're doing that internally.
04:53They're doing that within their application products.
04:55They offer the infrastructure layer to do that for companies that are building their own AI.
05:01And they're leaning into open-source and open-weight.
05:04Now that the relationship with open AI has changed,
05:08that's given them more liberty to do that,
05:10and it's put them in a better position given what you're talking about.
05:13Good night.
Comments