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Microsoft surging after beating fiscal third quarter expectations fueled by strong cloud growth. Steady demand for the software giant's cloud services, a welcome sign for investors amid President Trump's tariffs and economic uncertainty. Joining us now, we've got Brent Brace Lynn, who is the Piper Sandler equity research analyst. Great to have you here with us this morning. How are you really sifting through Microsoft's results right now and for the company trying to maintain cloud dominance and win that battle for cloud dominance, where do they stand in that effort?

Sure, thanks for having me uh Brad here. Um yeah, really uh impressive numbers out of Microsoft just given the current environment and backdrop. Uh really showcases uh how diversified and resilient this business model is, but let's be clear, this story really is all about cloud and AI. And that's really what surprised us the most. You actually saw an acceleration in their Azure business and and to put things into perspective, Azure is approaching uh $80 billion run rate, uh growing 35% year of a year. If this was a standalone uh business, this would be the fastest growing uh software infrastructure infrastructure company in the entire space. So, really impressive growth out of the uh Microsoft Cloud AI business.

And to what extent does that success justify the CapEx on AI?

Yeah, that's uh that's tricky, right? You're talking about a company that is aggressively investing in CapEx. They'll spend $86 billion this year. Uh investor scrutiny is certainly increasing or relative to is there an overbuild or not. What is interesting is it does look like uh CapEx on a on a year of year basis peaked last quarter at 97%. It still grew over 50% this quarter, but now you're talking about growth in CapEx slowing to less than 20% in Q4 and and we think it will grow only in the the low teens next year, which implies now you're starting to see monetization of the cloud and AI growth uh faster than CapEx. So yes, we've had a two-year investment. A lot of that investment has been around real estate, uh power contracts, uh concrete buildings, uh those are long-lived assets over half, we estimate about $70 billion of this spend for Microsoft over the last two years has been in those long-lived assets. We're now going to see the composition of what they spend CapEx going forward more tied to intra quarter uh demand signals around GPUs and CPU capacity and storage and networking. And I think a lot of the upfront investment around CapEx tied to long-lived assets, uh that should start to moderate. So we think the most important metric here, cloud and AI, we think we'll start to grow faster than the CapEx spend. Yeah, sorry. Didn't mean to cut you off. And it is actually to your point. They did talk about that on the call talking about the moderation in that capital expenditure growth rate here. And that also gets us into the conversation around what realistic margins investors should be expecting on a longer run rate, especially as we do see some moderation lower perhaps in the capital expenditure growth rate. It seems like the the figure that they're tossing around or thinking about is 67% Microsoft cloud gross margin. So how does that translate into continued growth for the rest of the business as well?

Sure. Um and and as we take a longer term perspective here around the margin profile, Microsoft in the past has not been afraid of of building um a large sizable new incremental business at slightly lower gross margins. You saw that in cloud, right? So the overall gross margin for Microsoft pre cloud, we're going back 15 years was actually higher. And you saw them build a $100 billion cloud business um and at a lower gross margin. More importantly, and so yes, we think as they build uh this AI business today that uh is north of 15 billion as that potentially gets to a $100 billion business, that will be a drag on gross margins. But this portfolio that Microsoft has built is is really driving outsized operating margins. Um so even at a lower gross margin over time, we think Microsoft can maintain uh 40% plus operating margins. This is really best in class in the tech space. And uh yes, it will come at a slightly lower gross margin, but it's really the operating margin driving over 130 billion of operating cash flow uh this year, that's the the key metric that we're uh paying attention to. And again, they have a proven track record. They added a $100 billion plus cloud business in the last 15 years, lower gross margin, but still was able to drive meaningful uh a profit operating profit margins for the company and operating cash flow.