Microsoft stock bounced today after a positive report from Bank of America Merrill Lynch. The shares have been trending downward since the company’s earnings report more than a week ago, but they’re up 1.58% at $50.66 today. Still, they must rally even more to reach the level they were trading at before the first quarter earnings report.

Microsoft Corporation Stock Rises As BAML Talks Up Intelligent Cloud

Windows Server not a concern

In a report dated May 2, BAML analysts Kash Rangan and Scott Shiao highlighted the positives in Microsoft’s April 21 earnings report, with their biggest plus being Intelligent Cloud. They note that investors have been focused on declines in Windows Server Products in fiscal 2017, although they actually don’t think this will happen. Assuming a 10% decline in transactional server revenue, flat annuity, and more than 60% growth for Azure, compared to 100% growth this year, Windows Server Product revenue would still increase by about 5%, they said. To come out flat overall, there would need to be a 35% decline in server transactional revenue, and all this comes before the Windows Server 2016 release.

They add that if Microsoft increases the price for Windows Server, it could see a $3.4 billion increase in server revenue, one-third of which would come in fiscal 2017 due to renewals of three-year enterprise agreements, which results in about $1 billion in annual incremental revenue. They said many models are only assuming that this category will grow by 1% to 2% in fiscal 2017 and 2018.

Intelligent cloud to boost Microsoft

Currently Azure’s incremental gross margin is -10% to -20%, so most investors think it will be quite a while before this metrics. The BAML team, however, expects Azure’s margin to move into the green in fiscal 2017, possibly going as high as 5% to 10%. They add that although this seems like a very sizeable improvement, Amazon Web Services had about a 14% operating margin when the segment was worth about $4.6 billion. Microsoft’s situation is different though because it invested a lot of the money on the front to reach 22 zones of availability in only a few years. As a result, the BAML team expects “significant leverage” in this area as it continues to grow. They believe this growth increase might offset up to 5% of fiscal 2017’s transactional decline.

Windows 10 could also be a big factor in fiscal 2017 as they note that in past cycles, unearned Windows revenue peaked in fiscal 2009 at $2.8 billion with the launch of Windows 7. Currently unearned revenue is at $2.8 billion, but right now it holds about $1 billion of Xbox Live revenue, so Rangan and Shiao said if Windows 10 is able to spur a similar upgrade cycle, unearned revenue could receive a boost in fiscal 2017.