Microsoft Stock Drops As AI Capital Expenditures Surge To $56 Billion

Microsoft CEO Satya Nadella speaks during a keynote address announcing ChatGPT integration for Bing ... [+] at Microsoft in Redmond, Washington, on February 7, 2023. - Microsoft's long-struggling Bing search engine will integrate the powerful capabilities of language-based artificial intelligence, CEO Satya Nadella said, declaring what he called a new era for online search. (Photo by Jason Redmond / AFP) (Photo by JASON REDMOND/AFP via Getty Images)

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Microsoft stock is falling short of the market averages. Through July 30, Microsoft stock had risen 14% — slightly below the S&P 500’s 14.6% increase, according to Google Finance.

After a mixed fiscal year 2024 Q4 earnings report, the company’s stock was down 3% in July 31 pre-market trading. Should investors view this dip as a buying opportunity? I think not.

That’s because Microsoft has not offered a clear enough explanation of how the company will accelerate its revenue growth after pouring tens of billions of dollars into generative AI.

While Microsoft has set itself apart from rivals by offering bespoke hints at how much generative AI contributed to Q4 growth, the company offered a sobering estimate of how many years would pass before that generative AI investment will pay off.

I have many questions for Microsoft, including the following:

Why did Azure revenue growth fall short of expectations in the fourth quarter? How much revenue is Copilot generating for Microsoft? How much capital has Microsoft invested in generative AI? Will Microsoft earn back that investment through profits from future generative AI product and service sales? If so, when will Microsoft's profits from AI products equal the company's investment in generative AI?

Microsoft discussed some of these questions during the earnings conference call. For instance, the company attributed the slower-than-expected cloud services growth to limits in its AI-related hardware and “weakness in a few European territories,” according to the Wall Street Journal, and “said it expects Azure growth to pick back up in the December quarter.”

Meanwhile Microsoft anticipates spending on generative AI assets “will be monetized over 15 years and beyond,” said Microsoft CFO Amy Hood, according to Reuters. I do not know what Hood means by “monetized over 15 years.”

Above all, the spending on generative AI could tail off unless a killer app — as iTunes was for the iPod — emerges for those costly AI chatbots, I argue in my new book, Brain Rush: How To Invest and Compete in the Real World of Generative AI.

I requested comment from Microsoft and will update this post if I receive a response.

Microsoft’s Q4 Performance And Prospects

While Microsoft’s reported revenue and earnings per share in excess of the Wall Street consensus, the company fell short on Azure cloud services growth for the quarter and forecast lower-than-expected revenue growth in the current quarter, noted Investor’s Business Daily.

Here are the key numbers:

Q4 2024 Revenue: $64.7 billion — up 15.1% from the previous year’s $56.2 billion and about $300 million more than the $64.39 billion expected, according to the London Stock Exchange Group consensus. Q4 2024 Earnings Per Share: $2.96 per share — up 10% and 1 cent higher than the LSEG consensus. Q4 2024 Net Income: $22 billion — up 10% from the year before, the Journal reported. Q4 2024 Azure Cloud Revenue grew 29% — below the prior quarter’s 31% growth and a percentage point less than analysts’ expectations, the Journal noted. Q1 2025 revenue forecast: $64.3 billion in the middle of the range — $800 million below the consensus estimate of $65.1 billion for the September quarter, according to FactSet.

Microsoft emphasized the constraints on growth resulted from lack of cloud services capacity. “As soon as we get capacity available to sell, we are selling it,” Brett Iversen, Microsoft’s head of investor relations, told the New York Times.

Will Microsoft Earn Back Its Generative AI Investment?

Just because a company is investing in a cool-sounding generative AI technology, that does not automatically mean many customers will pay a high enough price for the product to earn the profit needed to cover company’s initial outlay, notes Brain Rush.

To make the investment pay off, the company’s product must solve a painful customer problem more effectively than competing offerings.

In the case of generative AI, Microsoft has two relevant customer groups, companies using Azure to build generative AI chatbots and the employees and consumers whom those chatbots are aiming to help.

Microsoft is showing clear evidence of demand from the first customer group. AI services contributed “8 points to Azure’s revenue growth for the June quarter, compared with a 7-point contribution in the March quarter,” the Journal reported.

Microsoft is also offering office software — specifically, Word, PowerPoint and Excel — that is infused with an AI Copilot, for which the company charges an extra $30 per user per month.

Many companies are skeptical of the value of paying for this service. The interviews I conducted for Brain Rush suggest a lack of corporate enthusiasm. I doubt the company’s Copilot AI assistants for Microsoft 365 and its Bing search engine are killer apps that offer end users a much better solution to a significant unmet customer need than current products.

It does not surprise me that Microsoft “hasn’t broken out revenue from Copilot,” noted the Journal.

Meanwhile, Microsoft’s capital expenditures for generative AI are quite significant. Microsoft’s “total capital outlay with leases equated to nearly 23% of revenue for the just-ended fiscal year compared with an average of 14%,” the Journal reported.

For the fiscal year ending June 2024, Microsoft capital expenditures rose 75% to $55.7 billion, noted IBD.

Microsoft thinks that market demand justifies the spending. The company has received a “demand signal,” to justify those investments said CEO Satya Nadella in Tuesday’s investor conference call. Microsoft expects to spend more on capex in fiscal 2025 than it did in fiscal 2024, Hood told investors.

What Analysts Are Saying About Microsoft’s Stock

Analysts generally sound impatient with Microsoft. To be sure, one of them gives the company a break. “There is an A.I. halo effect that happens to the rest of Microsoft’s businesses,” Rishi Jaluria, an analyst at RBC Capital Markets, told the Times.

That halo effect springs from Microsoft’s disclosure of some AI details and Jaluri’s view that the company would have sold more Azure services if it had the extra computing capacity, noted the Times.

Other analysts seem to be running out of patience. Here are three examples:

Too high capex could fuel Microsoft bears. Microsoft’s higher-than-expected capital expenditures “could also be weighing on negative sentiment," CFRA Research analyst Angelo Zino told IBD. Azure’s disappointing Q4 growth concerns some investors. “There’s a segment of the investing community that is hyperfocused on very small changes to the Azure business,” Brad Reback, an analyst at Stifel Financial, told the Journal. Investors expect a return on investment in generative AI. “The street doesn't have a lot of patience,” Daniel Morgan, senior portfolio manager at Synovus Trust, told Reuters. “They see you spending billions of dollars and they want to see a pickup in revenue of that amount. If these companies do not hit it out of the ballpark and are far better than the estimates then they are going to be knocked back,” he added.

Wall Street sees some upside in Microsoft stock. Based on analyst ratings, shares could rise 19% to reach the average 12-month price target of $507.64, TipRanks notes.

If Microsoft can explain how the company will earn a return on its generative AI investments, that might give investors a reason to be more bullish about its stock.