Microsoft’s Azure Growth and AI Investments Under Investor Scrutiny

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When Microsoft reports earnings on Tuesday, investors will be keenly focused on one major question: Has the growth in its Azure cloud-computing business accelerated enough to justify the billions being spent on artificial intelligence infrastructure?

Widely regarded as a frontrunner in the race to monetize AI, thanks to its partnership with ChatGPT creator OpenAI, Microsoft is expected to show that Azure’s growth remained steady at approximately 31% between April and June, according to Visible Alpha data. This growth aligns with the company’s forecast, yet investors are looking for a more significant contribution from its AI initiatives in the fiscal fourth quarter, especially after AI accounted for 7 percentage points of Azure’s growth in the previous quarter.

Analysts polled by LSEG predict Microsoft’s capital spending surged about 53% year-over-year to $13.64 billion during this period, a substantial increase from the $10.95 billion spent in the prior quarter.

This surge in spending comes amid concerns that tech giants’ heavy investments in data centers might not yield immediate returns, which has affected U.S. stock market sentiment. Alphabet (GOOGL.O) saw its shares drop over 5% last week after reporting capital expenditures that exceeded estimates by nearly $1 billion, with only modest revenue boosts from AI integrations, leading to a selloff in major tech stocks.

Alphabet has stated that its capital expenditures will remain high for the rest of 2024, at or above $12 billion. “Investors will be very focused on Microsoft’s ability to continue to accelerate revenue growth, especially the portion related to AI,” said Gil Luria, senior software analyst at D.A. Davidson. “If revenue acceleration doesn’t materialize and increases in capex continue, investors may be disappointed.”

Microsoft has emphasized the necessity of current data center investments to overcome capacity constraints and capitalize on AI demand. This perspective is shared by other tech companies, including Alphabet, whose CEO, Sundar Pichai, recently stated that the risk of under-investing in AI infrastructure is far greater than over-investing.

The increased spending has enabled Microsoft to attract more business from its large enterprise clients by offering expanded AI cloud services and rolling out features like its 365 Copilot assistant for Word and Excel. The $30-per-month Copilot service, capable of summarizing emails or completing lines of code, is reportedly used by half of the Fortune 500 companies. However, Microsoft has not yet disclosed the revenue from this service, with analysts predicting its impact will become more evident in the latter half of 2024.

“While a lot of focus has been on consumer-facing applications like ChatGPT, generative AI is potentially a larger opportunity for enterprise, and Microsoft is incredibly well positioned to capitalize on their install base,” said Igor Tishin, an analyst at Harding Loevner, which counts Microsoft and Alphabet among its largest holdings.

Microsoft shares have risen about 13% this year, adding over $350 billion to its market value. The stock reached a record high on July 5 but has since dipped nearly 9% during the recent tech selloff, underperforming the S&P 500’s 14.5% rise this year.

The company is expected to post a 14.6% increase in overall revenue for the April-June period, compared with 17% growth in the previous quarter. This slowdown is primarily attributed to slower growth in its personal computing business, including Windows and the Xbox gaming division. Meanwhile, the productivity segment, which includes Office apps, LinkedIn, and 365 Copilot, is expected to grow by about 10%.