Microsoft forecasts slower cloud business growth in second quarter

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By Deborah Mary Sophia, Aditya Soni and Anna Tong

(Reuters) -Microsoft predicted increased spending on artificial intelligence this quarter but slower growth in its cloud business Azure, signaling that big AI investments were not enough to keep pace with capacity constraints at its data centers.

Shares of the Redmond, Washington-based company dipped 3.6% in after-market trading, giving up earlier gains. The company beat Wall Street’s estimates for first-quarter revenue and profit. 

Facebook-owner Meta, which reported results ahead of analyst expectations as well, warned of “significant acceleration” in AI-related infrastructure expenses, sending its share price down 3.1% in after-market trading.

Brett Iversen, Microsoft’s vice president of investor relations, reiterated that Microsoft will not be able to address AI capacity constraints until the second half of its fiscal year.

Microsoft forecast second-quarter Azure revenue growth of 31% to 32%, lagging the 32.25% growth expected on average by analysts, according to Visible Alpha. Azure revenue rose 33% in its fiscal first quarter ended Sept. 30, slightly ahead of estimates.

AI contributed 12 percentage points to Azure’s growth in the first quarter, compared with 11 percentage points in the prior three-month period.

Microsoft has been pouring billions into building its AI infrastructure and expanding its data-center footprint. For the quarter, Microsoft said capital expenditures rose 5.3% to $20 billion, compared with $19 billion in the previous quarter. That was higher than Visible Alpha estimates of $19.23 billion. 

Its hefty spending has raised concerns among some investors.

The company has been the worst performer among Big Tech names this year, having gained just over 15%, while Meta has surged 68% and Amazon.com climbed 28%.

Microsoft will spend over $80 billion this fiscal year, which began in July, according to analyst estimates from Visible Alpha. That is an increase of more than $30 billion from its last fiscal year.

“Microsoft is escalating a CapEx war that it may not be able to win. That level of investment is very high, it created a very big drag on free cash flow and will create a very big drag on margins going forward,” said Gil Luria, head of technology research at D.A. Davidson.

Microsoft’s rival Google has benefited from AI growth. On Tuesday, Alphabet said AI helped drive a 35% surge in its cloud business. Its shares closed up over 2.8% on Wednesday and were down 0.4% after the market closed.

OPENAI PARTNERSHIP

The quarterly earnings are Microsoft’s first since it restructured the way it reports its businesses to align them more closely with how they are managed. That move has, however, made it harder to estimate the quarter’s performance.

Earnings per share stood at $3.30, compared with analysts’ average estimate of $3.10, according to LSEG data. 

Revenue rose 16% to $65.6 billion in the fiscal first quarter ended September, compared with analysts’ average estimate of $64.5 billion, according to LSEG. 

The company is seen as the leader among Big Tech peers in the AI race thanks to its exclusive partnership with ChatGPT maker OpenAI. Microsoft’s Azure customers get access to OpenAI’s latest models, such as its o1 models, capable of answering challenging math, science and coding problems. 

In addition, Microsoft gets early access to infuse OpenAI’s technology across its product portfolio, such as in Bing and its enterprise applications such as Excel and PowerPoint, but that effort has not gone as well as expected.

Outside its cloud business, Microsoft reported revenue of $28.3 billion in its productivity business, which houses its Office suite of applications, 365 Copilot and its AI and speech-technology services. 

Microsoft’s personal-computing unit, home to its Windows operating system as well as devices including Surface and gaming products including Xbox hardware, content and services, reported a 17% rise in revenue to $13.2 billion. 

(Reporting by Deborah Sophia in Bengaluru and Anna Tong in San Francisco; Editing by Anil D’Silva and Rod Nickel)