Microsoft's Surging Backlog: A Backlogged Pipeline Worth Watching

When Microsoft reported its fiscal Q2 earnings, one number grabbed headlines: the company’s commercial remaining performance obligations climbed to $625 billion. That’s more than double the year-ago figure, sending a powerful message about demand for AI and cloud services. But here’s the catch—a swelling backlog doesn’t automatically translate into accelerating revenue growth. Investors need to look beyond the headline number to understand what this backlog really means for Microsoft’s future.

The $625 Billion Story: What It Really Tells Us

Microsoft’s commercial remaining performance obligations—the industry term for contracted work not yet recognized as revenue—represent genuine demand signals. When this metric skyrockets 110% year-over-year, it suggests customers are committing serious money to Microsoft’s cloud and AI services. The growth rate itself is telling: the 110% increase in fiscal Q2 dwarfed the 51% growth in fiscal Q1, indicating accelerating momentum.

But context matters. This backlogged work is multiyear in nature, meaning it will take considerable time to convert into actual revenue. When Microsoft disclosed that only 25% of its total commercial backlog would be recognized as revenue within the next 12 months, that expectation rose just 39% year-over-year. Translation: the company sees a surge in future commitments, not an imminent revenue explosion.

Why a Growing Backlog Doesn’t Always Mean Growing Revenue

Here’s where investors should pump the brakes. Despite the backlog soaring, Azure and Microsoft’s other cloud services showed a different story in fiscal Q2: revenue growth actually decelerated to 38% (in constant currency) compared to 39% the quarter before. This disconnect matters. A backlogged order book doesn’t guarantee you can convert it into revenue faster. It’s like a restaurant with a three-month waiting list still struggling with kitchen efficiency.

The OpenAI Concentration Risk: One Customer Looms Large

Dig deeper into that $625 billion backlog, and a significant vulnerability emerges: OpenAI accounts for 45% of it. That customer concentration risk is severe. When you strip out OpenAI, Microsoft’s commercial backlog growth rate drops to just 28% year-over-year—roughly one-quarter of the headline figure. This means Microsoft’s ability to sustain this backlog growth heavily depends on one strategic partner’s continued investment.

Capital Spending Surge: A Bet on Future Profitability

Microsoft is putting its money where its mouth is. The company’s capital expenditures hit $37.5 billion in fiscal Q2, up 66% year-over-year. That massive spending spree reflects confidence in cloud computing’s long-term potential, but it introduces risk. The bull case assumes these infrastructure investments will eventually unlock more efficient revenue conversion, with healthy margins attached. The bear case worries that revenue conversion takes longer than expected—or worse, that the economics prove less profitable than hoped, pressuring margins.

How the Current Valuation Stacks Up

Strip away the backlog speculation, and Microsoft’s current financial performance looks solid. The company grew revenue 17% year-over-year in fiscal Q2, with non-GAAP earnings per share up 24%. For a company trading at roughly 27x earnings, that’s respectable. The stock appears reasonably valued based on what Microsoft is actually delivering today rather than on speculative future revenue recognition.

The Bottom Line: Manage Expectations and Risk

Microsoft’s backlogged orders signal genuine demand for its cloud and AI offerings—that part is encouraging. However, investors should focus on what the company is accomplishing now rather than betting heavily on when and how that future revenue materializes. The stock looks attractive at current valuations, but investors should view Microsoft as a higher-risk position given its soaring capital expenditures. A measured allocation makes more sense than doubling down, especially with the uncertainty surrounding backlog conversion rates and future margin performance.