Will Microsoft’s big roll of the AI dice pay off?

Wall Street loves winners — winners of a specific kind, that is. Winners who beat short-term earnings and profit estimates, who can tout the best quarterly financial reports.

As for the long term — especially the very long term — Wall Street seems to care little at all. Stock prices are much more likely to spike when a company’s quarterly earnings show a sudden surge than when corporate execs detail a carefully thought-out long-range plan to dominate a fast-growing technology several years from now. 

That’s the lesson behind the stock market’s reaction to Microsoft’s earnings report in late July. The big news for investors? That Microsoft’s cloud-based Azure business grew “by only” 30% in the quarter, a single point less than the 31% that the company had projected. 

The next day, traders punished Microsoft. The company’s stock dropped more than four points while the overall market rose — the S & P Index, for example, was up a full 86 points. And all that, even as the company reported its revenue was up 15% and net income up 10%.

Wall Street yawns at Microsoft’s big AI news

The much more important news from the latest earnings call — that Microsoft is all in on artificial intelligence (AI) and spending heavily on long-term infrastructure that might not pay for itself for years — didn’t appear to count for Wall Street, at least as measured by the company’s stock price. 

Microsoft CFO Amy Hood told analysts on the call that the company’s $19 billion in capital spending was almost all related to AI and the cloud. That’s more than double what that number was two years ago, before the AI boom began in earnest. (Half the spending was for infrastructure-related costs, specifically, building the data centers required for the massive computing power AI requires.

As The New York Times described it: “The earnings report showed how the company is spending mightily to build the data centers and acquire the pricey chips that power A.I. technology. Microsoft’s capital expenses have grown every quarter since late 2022, when Mr. Nadella pushed his top executives to make big investments in A.I.”

All that spending bothered Wall Street, even though it’s necessary if Microsoft is to continue to dominate the AI market — and reap billions in profits from it in the future. Hood likely spooked investors when she explained that the big spending “will support monetization over the next 15 years and beyond.” 

To Wall Street, 15 years might as well be 15 eons; it’s looking for results now and in the short term, not over a distant horizon in the next decade.

Is Microsoft’s big AI bet a good one?

There is a reason financial markets are leery of companies that invest big in technologies that won’t pay off for years: they might not pay off at all. Technology changes quickly and companies can be fickle in their pursuit of the Next Big Thing. What seems like a sure shot today can turn into a big miss tomorrow. History is rife with examples — just look back at the hype around virtual reality. The payoff for it remains as elusive as ever and may not ever arrive. 

That’s not likely to happen with AI. It’s more likely that the bigger the bet, the bigger the payoff. Virtual reality, after all, has never brought in truly significant amounts of revenue. AI already has, and it’s still in its infancy.

In fact, Microsoft’s earnings were hurt this past quarter because the company can’t keep up with the demand for its AI services. Microsoft CEO Satya Nadella and Hood said on their earnings call that Microsoft could have sold more AI services this quarter if their data centers had the capacity to supply it. 

“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.

Those demand constraints on Microsoft’s AI services are expected to last through the remainder of the year. But by 2025, thanks to the new investments, Hood said, the company will soon start to see results. She expects cloud revenue, driven by AI demand, will grow somewhere between 28% and 29% in the first quarter of fiscal 2025. 

And that’s just a start.

The rise of a new ‘generational thing’

Nadella put it this way: “These are generational things once they get going with you.” He also noted that the company’s Copilot generative AI (genAI) companion to Microsoft 365 (formerly called Microsoft Office) “is on a growth rate that’s faster than any other previous generation of software we launched” for the Office suite.

I’m generally pretty cynical when it comes to the hype surrounding new technologies. More often than not, when tech CEOs promise the sun, the moon and the stars, they don’t even deliver earth-bound results, much less celestial ones.

This time is different. I’ve reviewed Copilot for Microsoft 365, and although it’s still got some problems, notably its penchant for occasional hallucinations, it’s a solid product that delivers real results. Demand will only increase. 

The same holds true for many other genAI and AI technologies (and Microsoft is building infrastructure for them as well.) So yes, Microsoft’s bet on AI is big, and true, it might not pay off for years. But there’s no doubt it’s a winner. 

Betting big will mean winning big as well.