Microsoft Corp. saw its shares decline following a forecast of slower growth in its cloud-computing division, reflecting the strain on the company's data center capacity as it ramps up AI infrastructure. Despite an otherwise strong quarterly earnings report, Microsoft's projections for Azure cloud revenue spooked investors, highlighting the challenge of meeting skyrocketing demand for AI-powered services while managing costly expansion efforts.
Azure, Microsoft's cloud-computing service and key AI driver, is expected to post growth of 31% to 32% for the current quarter ending in December. This is a slight decrease from last quarter's 34% growth and lower than Wall Street expectations. While the company reported a 16% revenue increase to $65.6 billion and exceeded profit forecasts at $3.30 per share, it warned of supply limitations within its data centers that will impact Azure's near-term growth.
Microsoft Chief Financial Officer Amy Hood explained that delayed data center capacity is restricting Azure's expansion. "We are in short supply," Hood said, noting that the company is working to balance resources to support AI demand. Microsoft shares fell 3.2% in premarket trading on Thursday, reflecting investor concerns about the impact of costly data center investments on growth and margins.
In recent quarters, Microsoft has aggressively invested in expanding its AI infrastructure, particularly through Azure. Capital expenditures surged 50% year-over-year to a record $14.9 billion in the first quarter, driven by data center construction and acquisitions of chips essential for running advanced AI applications. Yet, the rapid outlay has stirred questions about Microsoft's ability to convert these expenses into sustainable growth and returns.
Gil Luria, an analyst at D.A. Davidson, cautioned that the hefty data center spending may erode profitability over time. "Our fear is that the more they throw into data center buildout, the more the drag is going to be on margins," Luria said, pointing out that competitors like Amazon Web Services (AWS) and Google Cloud have achieved a more diversified and potentially cost-effective setup for AI services. Luria adjusted his Microsoft rating to "neutral," citing mounting pressure on margins from infrastructure investments.
Microsoft's AI-related sales-an increasingly important revenue source-have indeed shown strong gains, with Azure's growth fueled in part by AI deployments. AI products accounted for 12 percentage points of Azure's revenue growth last quarter, a rise from 11 points in the previous quarter, indicating robust customer adoption. CEO Satya Nadella noted that the company's AI business is on track to generate $10 billion in annual revenue, positioning it as Microsoft's fastest-growing segment. However, this rapid adoption has also intensified demand for AI resources, placing further strain on Microsoft's data center operations.
The slowing cloud growth comes amid Microsoft's strategic push to integrate AI across its product ecosystem, partnering with OpenAI to bring generative AI capabilities to tools like Office and Bing. Yet, a portion of Microsoft's earnings will show a $1.5 billion loss due to its investment in OpenAI, reflecting the substantial cost of backing the ChatGPT creator.
Despite the challenges, some analysts remain bullish on Microsoft's long-term AI potential. Morgan Stanley analyst Keith Weiss lifted his Microsoft price target by $42 to $548, arguing that investors will be rewarded for patience. Weiss noted that capital investments are likely to yield increased AI capacity by the second half of Microsoft's fiscal year, which should accelerate Azure's growth.
Meanwhile, Microsoft's broader business segments, including productivity tools and the newly launched Microsoft 365 Consumer cloud unit, continue to generate steady income. CFO Hood highlighted the incremental rise in average revenue per user, bolstered by AI-based features available for $30 per user, driving up adoption and revenue.
Search ad revenue also reported a strong performance, rising 19% as Microsoft's AI-enhanced Bing saw increased user engagement and higher advertiser spending. Additionally, Microsoft's personal computing and business software segments continued to support the company's earnings, offering diversification amid the costs of AI expansion.
Microsoft's AI investments are underscored by unprecedented spending: The company poured $55.4 billion into AI-related infrastructure last year, and that figure could rise to $80 billion in the current fiscal year, according to analyst estimates. While the investment signals Microsoft's confidence in AI, some analysts question whether the returns will justify the expenses. Barclays analyst Raimo Lenschow urged investor patience, noting that "the wait will continue for Microsoft's shares" as the company navigates short-term capacity constraints.
