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Microsoft shares fall amid disappointing cloud growth forecasts

Posted on by L. Dreeye
Microsoft shares fall amid disappointing cloud growth forecasts

Dinah Bass and Matt Day
| Bloomberg

Microsoft Corp. shares fell in extended trading after the software maker forecast slower quarterly cloud revenue growth, reflecting the company’s struggle to bring data centers online quickly enough to meet demand for artificial intelligence services.

Sales in the Azure cloud computing business will grow 31% to 32% in the current period, Microsoft executives said Wednesday on a call following its first-quarter earnings report. Azure’s revenue grew 34% in the period, adjusted for currency fluctuations, representing a slight slowdown from growth of 35% in the prior quarter.

The gloomy forecast followed an upbeat report in which the company said first-quarter revenue rose 16% to $65.6 billion and earnings rose to $3.30 per share, beating estimates.

But on a call with analysts, Chief Financial Officer Amy Hood said some of the data center capacity Microsoft was counting on to push artificial intelligence has not materialized. This will curb revenue growth in the Azure business in the current quarter ending in December.

“We’re shorthanded, and so we remain focused on getting this into a more balanced position,” Hood said in an interview.

Microsoft shares fell 3.7% in premarket trading Thursday after closing at $432.53 in New York.

“Our fear is that the more they invest in building data centers, the more margins will erode,” said Gil Luria, an analyst at DA Davidson & Co., who downgraded his rating on Microsoft shares to “neutral” during the September quarter. “This is not happening yet. They were able to cut costs elsewhere to continue to grow profits.”

CEO Satya Nadella has updated the software maker’s product line with artificial intelligence models from partner OpenAI. He’s now looking to attract enough paying customers to improved software and services to fuel Microsoft’s growth for years to come. At the same time, corporations are leveraging the company’s data center capabilities to develop their own artificial intelligence applications, driving demand in its closely watched Azure business.

Like cloud rivals Google and Amazon.com Inc., Microsoft has increased spending on building and leasing data centers needed to support power-hungry artificial intelligence services. Microsoft even recently struck a deal to buy nuclear power from the restarted Three Mile Island reactor to ensure it has enough electricity to meet its growing needs.

Quarterly capital spending in the first quarter of $14.9 billion was a record, up 50% from the same period a year earlier and exceeding analysts’ expectations. Before 2020, Microsoft had never spent so much money on real estate and hardware in an entire year.

In the second quarter, Microsoft’s “other income and expenses” line item, which accounts for investments, will show a loss of about $1.5 billion, largely due to Microsoft’s share of expected losses from OpenAI, CFO Hood predicted on the call. Microsoft, which has invested about $13.75 billion in the ChatGPT maker, is OpenAI’s largest shareholder.

Investors are looking for signs that Microsoft’s huge investments in artificial intelligence are paying off, and shares fell 3.7% in the September quarter compared with a 5.5% rise for the Standard and Poor’s 500 index. The decline underscored Wall Street’s concerns that the company has not yet realized enough returns from its investments in artificial intelligence and risks falling behind competitors flooding into the market. Azure’s forecast on Wednesday revived those concerns, even as the company reported strong growth in AI-related revenue and expressed optimism about the future development of AI products.

Microsoft’s main AI-related revenue streams fall into two categories: cloud services and Office’s built-in AI productivity assistants, which help workers summarize emails, transcribe conference calls and create slideshows. The company said 12 percentage points of Azure’s growth in the first quarter was attributed to artificial intelligence, up from 11 percentage points in the June quarter.

The company expects its artificial intelligence business to be on track to generate more than $10 billion in annual sales by the next quarter, Nadella said on the call.

Microsoft’s overall cloud revenue, a mix of products such as Office sales and Azure cloud services, rose 22% to $38.9 billion in the latest period.

Microsoft is signing up enterprise customers to use its AI-powered Office services, which have a monthly list price of $30 per user on top of the cost of the base Office product. Because of these costs, and because the products are still in the early stages of readiness, some customers have been slow to move toward testing and deployment.

However, rising prices are starting to benefit Microsoft. Average revenue per user is rising, Hood said in an interview, thanks both to the artificial intelligence offering and a more expensive version of the Office suite called E5.

Search advertising revenue also posted better-than-expected growth of 19%, excluding currency effects, Hood said. Microsoft has introduced artificial intelligence into its Bing search service, and those improvements have increased both the number of users and the prices advertisers are willing to pay, she said.

The results came a day after Alphabet Inc.’s Google posted quarterly cloud sales that rose more than analysts had forecast, to $11.4 billion, up 35% from a year earlier. Amazon, the largest cloud services provider, is scheduled to report earnings on Thursday.

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With the assistance of Vlad Savov.