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A steady escalation in spending on AI data centres has tested Wall Street’s patience this year. But this week, investors seemed to set aside some of their unease to contemplate the potential return on all those promised gigawatts of new computing power.
The latest quarterly earnings from some of the biggest tech companies out on Wednesday hinted at a new, higher growth trajectory that may be starting to take hold. Profit margins of the largest cloud computing companies registered an unexpected lift. It would all seem to show that the payback from the AI infrastructure boom may be coming into view, were it not for one inconvenient fact: even with growth rates picking up, the capital spending keeps spiralling ever higher.
The financial strain of the data centre boom is starting to show. The combined free cash flow — operating cash flow minus capital expenditure — of Alphabet, Amazon, Meta and Microsoft dropped to $22bn in the latest quarter, roughly half the level of a year before.
That the picture wasn’t much worse owed everything to an extraordinary jump in the companies’ earnings. The combined operating cash flow of the four rose nearly a third, an increase of $36bn, preventing the capital spending binge from dragging them, as a group, into negative cash flow territory.
The stakes coming into this week were high. The past month had already seen a sharp rebound in stock market sentiment, with the shares in the four companies rising over the past month by anything from 16 per cent (Microsoft) to 25 per cent (Amazon). In the event, Alphabet beat even the most optimistic forecasts, as AI-powered search supercharged its core product and revenue growth at its cloud division accelerated a startling 15 percentage points from the previous quarter, to 63 per cent.
The cloud divisions of Microsoft and Amazon also did better than expected, though they were put in the shade by Google. But the numbers were strong enough to underline the fact that the cloud business — selling computing resources to others — has become the main flywheel driving Big Tech’s AI engine.
The question left hanging in the air is whether all the new AI computing power is being turned into the sort of applications and services that customers will be willing to pay a premium for, lifting profit margins and justifying the investment binge. For this quarter, at least, the signs were encouraging. Alphabet, Amazon and Microsoft each registered an unexpectedly robust improvement in operating profit margins.
Microsoft chief executive Satya Nadella put the change down to the growing use of AI agents, most notably for coding. Microsoft itself has struggled to show its huge base of white-collar workers is ready for AI. It revealed earlier this year that only about 3 per cent of paying customers for its productivity tools had also chosen to pay for its Copilot AI service. This quarter, however, it said the number of Copilot users had risen a third. According to Nadella, agent-like capabilities are making the service more useful.
The tech companies also attributed the margin gains to adjustments in their operating and business models for AI. Google, for instance, said a surprising jump in earnings in its cloud division was due to engineering breakthroughs that had enabled it to deliver AI services far more cheaply.
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Microsoft chief financial officer Amy Hood, meanwhile, said charging for usage of new AI models, while at the same time continuing with traditional per-seat subscriptions for software, was proving effective. This, she added, has made the transition to AI more positive than the earlier transition to cloud computing — a time when worries about margins dogged Microsoft for a protracted period.
Yet another round of capital spending increases still casts a long shadow. Meta’s shares slumped as it warned of higher spending. Its operating margin fell nearly one point, helping to explain its recently announced round of job cuts. The costs of the capital spending boom have barely started to show through in income statements yet. Google chief financial officer Anat Ashkenazi warned that depreciation levels were set to jump as the spending starts to hit, forcing even greater attention to efficiency.
The message to tech workers: even as their employers enter a new phase in the AI boom, job prospects are not looking any more secure.
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