Results: Microsoft 3q26
Is paid Copilot taking off? Distribution advantages in action.
Original review: Can Microsoft Compete? Part 1; Part 2; Part 3 coming this week.
Tag for finding my other articles on this stock: MSFT
Key takeaways
EPS compounding high teens. 35% q/q growth in paid Copilot seats perhaps the most significant individual datapoint.
Thesis and valuation update
No change to thesis. Intelligence is fragmenting and commoditising. Microsoft is well-placed to distribute commoditised intelligence to enterprise. TAM is vast. Stock trades at 21x June 2027 EPS.
Notes
Revenue +15% c/c, gross profit 13%, EBIT 16%, EPS 18% excluding OpenAI stake impact.
Infrastructure depreciation and agent usage decrease gross margins, offset by infrastructure efficiency gains at the operating level.
Cloud revenue +25% c/c at 66% gross margin.
Azure revenue +39% c/c, ahead on early delivery of capacity.
AI business $37bn ARR, +123%. Includes paid Copilot, Azure AI consumption revenue (OpenAI, Foundry, AI-driven compute/networking/storage, etc.), revenue attributed to AI features embedded in core products.
M365 Commercial seats +6%.
EBIT margin 46%.
Headcount down as they build fast, agile teams.
CFOPS +26%. Capex $31.9bn, 2/3rds on short-lived items (which is what correlates with revenue). FCF $15.8bn.
FY capex $190bn including $25bn for higher component prices. Demand exceeds supply at least through 2026.
2 mutually-supportive priorities as Agents drive TAM:
Building the world’s leading cloud and AI infrastructure for third party agents.
Building high-value first party agents across core domains like productivity, coding, and security.
Infrastructure: optimising every layer - DC design, silicon, system software, model architecture.
Reducing time to deploy, increasing efficiency. More revenue, sooner, at lower cost.
Maia 200 now live in 2 DCs and offers 30% more tokens per dollar than the latest chips in their fleet.
40% improvement in inference throughput for Copilot’s most-used models, on software and hardware optimization.
Enterprise data and context: “across Fabric, Foundry, Microsoft 365 and our Security Graph, we are building a unified IQ layer for organizational intelligence…And as AI usage grows, so does the context layer, creating a flywheel that continuously improves the grounding, relevance and effectiveness of every agent”.
Cosmos DB revenue +50% y/y driven by AI.
Fabric has 35k paid customers, up 60% y/y.
Amount of data in OneLake (which underlies Fabric) grew 4x.
15k customers use Foundry and Fabric, up 60% y/y, connecting agents to data.
Third party agents.
AI Foundry offers 11,000 models. 10,000 customers have used more than 1. 5,000 have used open source models. Foundry has c.60k users but they vary in sophistication.
Agent 365 is the “control plane” - governance, identity, security and management frameworks for agents. “Tens of thousands of companies are already managing tens of millions of agents in Agent 365”.
First party agents.
“Here we are in 2026 and the most exciting things are plug-ins in Word or Excel or CLIs in coding…that means we have a structural position in knowledge work, coding, security, which are the big TAMs”.
Copilot is evolving from a chat assistant to a coworker, executing long running tasks across key domains. Innovation is accelerating - M365 saw 625 updates over 12 months, up 50%. Includes intelligent auto-routing to the right model, and use of multiple models to improve responses.
Copilot adoption and engagement are exploding. M365 Copilot seat adds up 250% y/y. M365 Copilot paid seats up ~35% q/q to >20m and accelerating. MAUs of first party agents is up 6x ytd. Copilot queries per user are up 20% q/q. Copilot weekly engagement is now at the same level as Outlook (impressive but definition not clear - likely the percentage of licensed users who use it at least once a week).
WorkIQ now spans 17 exabytes of data, growing 35% y/y, with billions of e-mails, documents, chats, Teams meetings, and SharePoint sites added each day. “Copilot is uniquely valuable at work where nearly every task depends on organizational context. Work IQ grounds Copilot responses in the full context of an organization, including people, roles, documents and communications, all within the company’s security boundary….this is not some static database. It’s the most important database in any company that is constantly changing every second”. And as Copilot adoption grows, Copilot conversations and artifacts get added, making the data richer.
1st-party models differentiate high-value Copilots and reduce COGS. New voice transcription and image generation models increase GPU efficiency by 67% and 260%, respectively.
Examples
LinkedIn Talent Solutions helps hirers automate sourcing, screening, and messaging - $450m ARR already.
Security Copilot customers up 2x y/y.
GitHub “is seeing unprecedented growth driven by proliferation of agentic coding”. Enterprise subscribers to Github Copilot up near 3x y/y, the majority using multiple models.
Shifting to seats + consumption model (aka seat + agent).
Seats include some consumption. Long term consumption commitments will get discounts. Additional consumption charged on top.
Customer Service is at the forefront with 60% of customers now buying usage-based credits.
Github Copilot is moving to seat + usage too.
On a like-for-like basis this reduces bookings, since seats are booked up front and usage is real time, but not revenue.
As value-add rises, this accelerates revenue growth in M365 Commercial.
Windows monthly active devices >1.6bn, “and over time, Windows value will extend to deliver unmetered intelligence at the Edge”. Bing MAUs topped 1bn.
OpenAI agreement evolution maintains win-win dynamic. Still have royalty-free access to a frontier model through 2032.
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Pete
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