Following a meeting with Microsoft (MSFT) executives, Morgan Stanley analyst Keith Weiss believes the tech giant’s Azure unit could provide “meaningful upside.”
“Azure AI (excluding OpenAI revenue share) gross margins could be ~20% already (based on our framework, analysis, and read-through from management commentary),” Weiss wrote in a note to clients. As such, he upped his estimates on Azure and believes that Azure’s artificial intelligence-related gross margins could hit as high as 30% (or more) by fiscal 2029.
“[We] think Azure AI margins can surpass 40%, implying very significant levels of upside to our model in the coming years,” Weiss added. “Conversations with Microsoft leadership bolsters our confidence in demand trends supporting the accelerating revenue growth [in constant currency] from FQ1, expanding operating margins, with demand signals across bookings, RPO, and product usage accelerating faster than we expected. Bottom line, with shares trading at 23X our CY27 GAAP EPS of ~$20.65, the durability of top-line demand and potential for further margin expansion displayed in Microsoft’s Q1 print remain well underpriced, keeping Microsoft our Top Pick in large-cap software.”
In addition, Weiss, who has an Overweight rating and $650 price target on Microsoft, said the recent $250B deal with OpenAI (OPENAI) paves the way for even further upside.
“[Our] Azure forecasts to do not go up by nearly the amount of the potential contribution from that OpenAI deal,” Weiss added. “If this [remaining performance obligation] gets recognized fully in revenue, this would represent another vector of upside to our model.”