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31 January 2025

Microsoft Azure Growth Hits Snag Amid AI Spending Surge

The tech giant faces investor concerns as cloud revenue growth slows to 31% amid rising competition.

Microsoft’s Azure cloud computing business has hit a snag, reporting a more pronounced slowdown in quarterly growth than anticipated, raising red flags for investors concerned about the tech giant's hefty investments aimed at bolstering its AI offerings.

The tech titan unveiled its second-quarter financial results for the fiscal year 2025 on January 29, 2025, showing Azure's revenue rising by 31%, down from 34% growth the previous quarter, and slightly below the 32% growth forecast by analysts. This cooling growth has sparked trepidation among investors, leading to approximately a 4% drop in Microsoft's share prices during after-hours trading.

Microsoft, long regarded as the vanguard of AI commercialization through its partnership with OpenAI—the developer behind ChatGPT—has continued to invest heavily across its platforms. Despite these efforts, including launching several AI products under the Copilot brand, the results haven't converted as rapidly to revenue as the company had hoped.

Amy Hood, Microsoft’s CFO, admitted to these challenges, stating, "Overall revenue growth is being limited by the company’s still lack of sufficient data center capacity to meet customer demand." This capacity constraint primarily stems from the massive demand for AI capabilities, compounded by the competition from rivals, such as Google and Amazon, which are also ramping up their investments.

For the second quarter, Microsoft's total revenue experienced a 12% year-over-year increase, amounting to $69.6 billion, above the consensus estimate of $68.78 billion. The company's earnings per share also surpassed projections, standing at $3.23 per share versus the expected $3.11. This broader performance was buoyed by Azure, which contributed significantly to the revenues of the Intelligent Cloud unit reporting $25.54 billion, though it narrowly missed the $25.76 billion projection, marking 19% year-over-year growth.

Crucially, Microsoft indicated its cloud growth was bolstered by AI, which accounted for 13 percentage points of Azure's growth, increasing from 12 points the previous quarter. AI services alone have surged—with revenue growth hitting 157% year-over-year for Q2, igniting optimism among some analysts about its long-term potential. "We see AI as the primary driver for our cloud growth, and this sector is continuing to expand significantly," said CEO Satya Nadella, underscoring his confidence amid the looming challenges.

Despite these promising trends, Wall Street's mood has been tempered by the reality of increased competition, particularly following the entrance of Chinese competitor DeepSeek, which recently released open-source AI models purportedly rivaling those of Microsoft at significantly lower costs. This intensifying competition, coupled with Microsoft's expected capital expenditures of $22.3 billion—exceeding anticipated outlays of $21 billion—has prompted some skepticism over the necessity and timing of its spending spree.

"This slowdown is concerning as it reflects broader challenges faced by Microsoft’s Intelligent Cloud division," noted financial analysts at Bloomberg, echoing the sentiment of worried investors.

Microsoft's ambition to invest $80 billion this fiscal year on AI data center expansions indicates its commitment to addressing capacity issues. This expanded infrastructure is anticipated to come online by the end of the fiscal year, potentially positioning the company for stronger revenue growth moving forward as AI demand continues to escalate.

Looking to the future, Microsoft maintains nearly $300 billion worth of commercial service contracts expected to contribute to future revenues, with commercial bookings up by 67%, exceeding expectations. This points to strong demand for Azure, as Hood indicated, attributing considerable contributions from commitments made by OpenAI.

While concerns about Microsoft's slowing growth persist, analysts continue to highlight the company's strengths, particularly its positioning within the burgeoning AI sector. Following the financial report, analysts have maintained a “Strong Buy” consensus rating for Microsoft, buoyed by its resilient performance and promising growth projections anchored by its cloud and AI investments. The average price target for Microsoft stock implies roughly 15.4% upside potential over the next year.

Microsoft’s effort to balance current challenges with sound investments could spell the difference between short-term setbacks and long-term triumphs. Analysts and investors alike will be watching closely to see how Microsoft capitalizes on its leadership position and navigates through the competitive cloud waters.