Microsoft Drops 7% as Azure Growth Slows to 39%
Cloud revenue misses elevated expectations despite record $81.3B quarter. Capacity constraints and margin guidance weigh on shares.
Microsoft posted a record quarter on Wednesday night and the stock dropped 7%.
That disconnect tells you everything about where expectations stood heading into earnings. Azure revenue grew 39% in constant currency—impressive by any normal standard, but below the 40%+ some analysts had projected. More concerning: CFO Amy Hood warned that capacity constraints would persist through fiscal year end.
The cloud giant is selling all the AI compute it can build. The problem is it can't build enough.
The Numbers
Q2 FY2026 revenue came in at $81.3 billion, up 15% in constant currency and above the $80.2 billion consensus. Net income soared 60% on a GAAP basis to $38.5 billion, boosted by a one-time tax benefit.
The Intelligent Cloud segment generated $32.9 billion in revenue, up 28% year-over-year. Azure specifically grew 39% in constant currency—strong, but decelerating from 40% in Q1.
Total cloud revenue across all segments hit $51.5 billion, marking a 24% increase. Microsoft's commercial cloud gross margin expanded to 67%, up from 66% a year ago.
Those are objectively good numbers. The market wanted great.
The Capacity Problem
Hood addressed the elephant in the room directly: "We've worked very hard to try to mitigate it as best we can, but we have been short in Azure."
Microsoft is facing a classic supply constraint. Enterprise customers want more AI compute than the company can provide. Data center buildouts take time. GPU supply remains tight despite NVIDIA's production ramp. The result is unfulfilled demand that shows up as slower reported growth.
Capital expenditures for the quarter neared $35 billion, with roughly half going to GPUs and CPUs for AI workloads. Microsoft is spending aggressively but still can't match demand.
For bulls, this is a high-quality problem. Customers want to spend more than Microsoft can accept. For traders, it means growth rates will stay constrained until new capacity comes online—likely not until late 2026 at the earliest.
The OpenAI Factor
One bright spot: commercial remaining performance obligation jumped 110% to $625 billion, driven partly by OpenAI's $250 billion cloud commitment announced during the quarter.
However, 45% of that backlog is tied to OpenAI. Strip that out and the remaining business grew 28%—solid but not spectacular. The concentration raises questions about what happens if OpenAI ever builds its own infrastructure or diversifies cloud providers.
CEO Satya Nadella struck an optimistic tone: "We are only at the beginning phases of AI diffusion and already Microsoft has built an AI business that is larger than some of our biggest franchises."
What It Means
Microsoft's results illustrate the challenge facing AI infrastructure plays. Demand exists. Monetization is happening. But the buildout takes longer than the market's patience allows.
The 7% after-hours drop likely overshoots. Azure growing 39% with supply constraints is fundamentally healthy. But traders who expected Microsoft to blow past estimates—like Meta did hours later—got disappointed.
Coming into earnings week, we noted that Azure was under the microscope as the clearest proxy for enterprise AI adoption. The answer: adoption is strong, but infrastructure limits are real.
For the broader Markets picture, Microsoft's results suggest AI spending is hitting practical ceilings, at least temporarily. Companies want to spend but can't find the supply. That's good for chip stocks and data center REITs. It's frustrating for cloud providers stuck in line for GPUs.