Investor Spotlight on Microsoft’s AI Spending Ahead of Earnings Report

As Microsoft gears up to release its earnings report on Tuesday, all eyes are on whether the growth in its Azure cloud-computing division can justify the extensive investments made in artificial intelligence infrastructure. Investors are particularly keen to see if these investments will yield the anticipated returns.

Microsoft, widely regarded as a leader in the AI space due to its partnership with ChatGPT creator OpenAI, is forecasted to report a consistent 31% growth in Azure from April to June, according to Visible Alpha data. This growth is in line with the company’s forecast, yet there is a significant expectation for AI to contribute more substantially to Azure’s growth in the fiscal fourth quarter, having already added 7 percentage points in the prior quarter.

Analysts from LSEG estimate that Microsoft’s capital expenditures have surged approximately 53% year-over-year to $13.64 billion, a notable increase from the $10.95 billion spent in the previous quarter. This considerable rise in spending highlights Microsoft’s aggressive push to expand its AI capabilities.

Wall Street, however, is increasingly worried about the immediate returns on these massive data center investments by tech giants. This concern has had a ripple effect on the U.S. stock market. For instance, Alphabet’s shares fell over 5% after its capital expenditure report exceeded projections by nearly $1 billion without substantial immediate AI revenue benefits.

Alphabet has indicated that its capital expenditures will remain high throughout 2024, averaging $12 billion per quarter. This raises questions among investors about Microsoft’s ability to sustain revenue growth, particularly from AI, amid rising capital expenses. Gil Luria, a senior software analyst at D.A. Davidson, warns that if revenue acceleration from AI doesn’t materialize and capital expenditures continue to increase, investors may be disappointed.

Microsoft has defended its increased spending, asserting that it is necessary to overcome current capacity constraints and meet the growing demand for AI services. This perspective is shared by other tech leaders, including Alphabet’s CEO Sundar Pichai, who emphasized the greater risk of under-investing in AI infrastructure compared to over-investing.

This strategic investment has enabled Microsoft to expand its AI cloud service offerings for large enterprise clients. One notable offering is the 365 Copilot assistant for Word and Excel, priced at $30 per month. This service, which can perform tasks such as summarizing emails and completing lines of code, is already being utilized by half of the Fortune 500 companies. Despite its early success, Microsoft has yet to disclose the revenue generated from Copilot. Analysts believe that the financial impact of Copilot will become more apparent in the latter half of 2024.

Igor Tishin, an analyst at Harding Loevner, a $55 billion asset management firm, highlighted that while consumer-facing applications like ChatGPT attract significant attention, the enterprise market offers a much larger opportunity for Microsoft. The company is well-positioned to leverage its extensive client base in this space.

Despite a 13% rise in Microsoft’s shares this year, adding over $350 billion to its market value, the stock has recently fallen by nearly 9% amid a broader tech selloff. This recent decline contrasts with the S&P 500’s 14.5% rise this year.

For the April-June period, Microsoft is expected to report a 14.6% increase in overall revenue, slightly down from the 17% growth in the previous quarter. This slowdown is primarily attributed to weaker performance in its personal computing segment, which includes Windows and Xbox. In contrast, the productivity sector, which includes the Office suite, LinkedIn, and 365 Copilot, is anticipated to show approximately 10% growth.

As Microsoft navigates these financial waters, the upcoming earnings report will be crucial in addressing investor concerns and demonstrating the tangible benefits of its significant AI investments. The company’s ability to balance high capital expenditures with sustained revenue growth will be key to maintaining investor confidence and market stability in the rapidly evolving tech landscape.