Microsoft Ramps up AI Investments Despite Cloud Business Slowdown

Microsoft (NASDAQ:MSFT) reported better-than-expected results for its fiscal fourth quarter, however, shares still fell after the management said on the earnings call that it expects its capital expenditures will rise sequentially each quarter on the back of the massive AI investments.

For FQ4, Microsoft said its sales rose 8.3% year-over-year to $56.19 billion, ahead of the consensus for revenue of $55.49 billion. The Intelligence Cloud business unit generated $24 billion in FQ4 sales, topping the consensus for $200 million. At constant currency, Microsoft’s revenue rose 10%. Microsoft Cloud revenue came in at $30.3 billion, also marginally ahead of the Street. On the bottom line, the company posted adjusted profit per share of $2.69 as operating income came in at $24.25 billion. Analysts were looking for an EPS of $2.56 and operating income of $23.28 billion.

“Organizations are asking not only how – but how fast – they can apply this next generation of AI to address the biggest opportunities and challenges they face – safely and responsibly,” said Satya Nadella, chairman and chief executive officer of Microsoft.

“We remain focused on leading the new AI platform shift, helping customers use the Microsoft Cloud to get the most value out of their digital spend, and driving operating leverage.”

For this quarter, Microsoft anticipates 25% to 26% in constant-currency Azure growth. The business grew 27% in FQ4 in constant currency, in line with the company’s guidance. For the FQ3, for example, the Azure business recorded a 31% sales growth year-over-year.

Massive Progress on the AI Front

As expected, the generative artificial intelligence (GenAI) theme was the dominant topic on the call. CEO Nadella mentioned AI twice in his prepared press release remarks in addition to the 59 mentions on the subsequent earnings call.

Investors had two key topics heading into the call: the Azure growth, and when Microsoft will start reaping the benefits of its massive GenAI investments. Microsoft said it is focused on three areas: Attract more customers and help them use the breadth and depth of its Cloud platform; invest in the new AI platform; and drive operating leverage.

“Azure continues to take share as customers migrate their existing workloads and invest in new ones. We continue to see more cloud migrations as it remains early when it comes to long-term cloud opportunities,” Nadella said on a call.

The chief executive added that Microsoft is enjoying “great momentum” when it comes to its partnership with ChatGPT developer OpenAI. Companies like IKEA, Volvo (OTC:VLVLY), Snowflake Inc (NYSE:SNOW), KPMG, Mercedes Benz (OTC:MBGAF), Moody's (NYSE:MCO), and Flipkart have already signed up to use the company’s AI services. Microsoft is adding almost 100 new customers every time, Nadella added.

The management also mentioned business giants like Deutsche Bank (ETR:DBKGn), Novartis (NYSE:NVS), Siemens (OTC:SIEGY), and Wells Fargo (NYSE:WFC) as some of the companies that are using its Microsoft 365 premium offerings. The number of devices running Windows 11 has more than doubled in the last year, the company said.

“We continue to use AI to help our members and customers connect to opportunities and tap into the experiences of experts on the platform. Our AI-powered collaborative articles are now the fastest-growing traffic driver on LinkedIn,” Nadella also noted.

Investors were also interested to hear about the progress with Bing, especially amid growing concerns that Alphabet’s Google (NASDAQ:GOOGL) may lose a portion of its market share to its key rival. Nadella said that Bing users have engaged in more than 1 billion chats and created more than 750 million images with Bing Image Creator. Ultimately, Microsoft Edge gained market share for the ninth consecutive quarter.

AI is Here… And It's Expensive

Microsoft shares were modestly hit after the company said its capital expenditures were $8.94 billion in the fiscal fourth quarter. Chief Financial Officer Amy Hood said on the earnings call that the company’s capital expenditures will rise sequentially each quarter “as we scale to meet demand signals.”

“For FY '24, the impact will be weighted toward H2. To support our Microsoft Cloud growth and demand for our AI platform, we will accelerate investment in our cloud infrastructure,” the CFO noted on the call.

“We are committed to driving operating leverage and therefore, we will manage our total cost growth across COGS and operating expenses in line with the demand signals we see, as well as revenue growth.”

Hood noted that Cloud's gross margin was 72%, fueled by improvements in Office 365, but partially offset by lower Azure margin “and the impact of scaling our AI infrastructure to meet the growing demand.” The company’s operating expenses grew 2% with the head count basically flat compared to a year-ago period.

“We'll continue to invest in our cloud and AI infrastructure while scaling with growing demand so we can lead the AI platform wave. And finally, we'll align our costs with growth as we are committed to driving operating leverage,” Hood concluded.

Microsoft shares rose to record highs last week after the company announced pricing for some of its AI products. Microsoft 365 Copilot will be priced at $30 per user, per month for Microsoft 365 E3, E5, Business Standard, and Business Premium customers. This is higher than what analysts were expecting and it shows Microsoft’s robust pricing power.

Summary

Microsoft stock fell modestly in the aftermath of the FQ4 earnings report after the company’s CFO said on the earnings call that capital expenditures are expected to increase to support the AI demand. The market reaction is justified given the strong year-to-date rally in Microsoft shares and high investor expectations into earnings, while on the other hand, Microsoft’s cloud business continues to face a slowdown.

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Disclaimer:

Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.