Microsoft shares drop on disappointing cloud growth forecast

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

Sales from the closely watched Azure cloud-computing business will rise 31% to 32% in the current period, Microsoft executives said Wednesday on a call following its first-quarter earnings report. Azure revenue posted a 34% gain for that period, adjusted for currency fluctuations, which was a slight deceleration from the 35% growth a quarter earlier.

The dour outlook followed an otherwise upbeat report, during which the company said first-quarter revenue increased 16% to $65.6 billion and profit rose to $3.30 a share - beating estimates.

But on a call with analysts, Chief Financial Officer Amy Hood said some data center capacity Microsoft had been counting on for its push into artificial intelligence didn’t materialize. That will constrain revenue growth in the Azure business during the current quarter, which ends in December.

“We are in short supply, and so we remain focused on getting that into a more balanced position,” Hood said in an interview.

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

“Our fear is the more they throw into data center buildout, the more the drag is going to be on margins,” said Gil Luria, an analyst at D.A. Davidson & Co., who cut his rating on Microsoft shares to “neutral” during the September quarter. “That isn’t happening yet. They’ve been able to cut enough costs elsewhere to still expand margins.”

Chief Executive Officer Satya Nadella has overhauled the software maker’s product line with AI models from partner OpenAI. He’s now seeking to recruit enough paying customers to the souped-up software and services to drive Microsoft’s growth for years to come. At the same time, corporations are tapping the company’s data-center capacity to power development of their own AI applications, buoying demand in its closely watched Azure business.

Like cloud rivals Google and Amazon.com Inc., Microsoft has ramped up spending to construct and rent the data centers required to fuel power-hungry AI services. Microsoft even struck a deal recently to purchase nuclear power from a restarted reactor at Three Mile Island in an effort to ensure that it has sufficient electricity to meet its growing needs.

Quarterly capital expenditures in the first quarter, at $14.9 billion, were a record, up 50% from the same period a year earlier and exceeding analysts’ expectations. Prior to 2020, Microsoft had never spent that much on property and equipment over the course of a full year.

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

Investors have been watching for signs that Microsoft’s hefty investments in AI are paying off, and the stock fell 3.7% during the September quarter, compared with a 5.5% increase in the Standard and Poor’s 500 Index. The decline underscored Wall Street concerns that the company wasn’t yet realizing sufficient gains from its AI investments, and risks falling behind as rivals pile into the market. The Azure forecast on Wednesday revived those concerns, even as the company reported robust AI-related revenue gains and expressed optimism about further momentum for AI products.

Microsoft’s main sources of AI-related income fall into two categories - cloud services and AI-enhanced productivity assistants baked into Office, which help workers summarize emails, transcribe conference calls and create slideshows. The company said 12 percentage points of Azure’s first-quarter growth was attributable to AI, compared with 11 points in the June quarter.

The company expects its AI business to be on track to bring in more than $10 billion in sales over the course of a year by sometime in the next quarter, Nadella said on the call.

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

Microsoft has been signing up corporate clients to use its AI-infused Office services, which carry a monthly list price of $30 per user, in addition to the cost of the basic Office product. Because of that expense, and because the products are still at an early stage of readiness, some clients have moved slowly with trials and deployments.

Still, the price increases are starting to benefit Microsoft. Average revenue per user is ticking up, Hood said in the interview, owing both to the AI offering and a higher-priced version of the Office suite called E5.

Search ad revenue also posted better-than-expected growth of 19%, excluding the impact of currency, Hood said. Microsoft has been baking AI into its Bing search service, and these improvements have boosted both user volume 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 grew more than analysts had projected, rising to $11.4 billion, a 35% increase from the year-earlier period. Amazon, the biggest cloud provider, is scheduled to report earnings on Thursday.