Microsoft’s AI dreams make for an expensive reality

The $3 trillion software giant’s fiscal fourth-quarter results late Tuesday showed a couple notable trends. Revenue growth in its cloud business slowed during the June quarter, with the Intelligent Cloud segment missing Wall Street’s projections for the first time in nearly two years, according to FactSet data. Microsoft also spent an eye-popping $19 billion in cash capital expenditures and equipment purchased under finance leases during the quarter. That is equivalent to what the company used to spend in an entire year—just five years ago.

The blowout spending isn’t a shock; Microsoft and its big tech peers have been broadcasting their plans since last year to invest heavily in the generative-AI opportunity. But Microsoft’s total cloud revenue of $36.8 billion was about 2% short of analysts’ estimates, while revenue growth at its Azure public cloud unit came in at the low end of the company’s own projection. That also contrasted with stronger-than-expected cloud revenue growth reported last week by Google.

Microsoft’s shares slipped nearly 3% following the results in after-hours trading Tuesday. That implies a worse quarter than it was; the company’s other business units exceeded expectations, and Microsoft wrapped up the fiscal year with a record $109 billion in operating income. That equates to an annual operating margin of 44.6%—a level the company hasn’t seen in more than two decades. Microsoft also affirmed on its earnings call Tuesday that it plans to deliver another year of double-digit growth in both revenue and operating income for fiscal 2025.

But investors who were once willing to write blank checks to big tech companies that invest in AI have grown more wary of late. Microsoft, Amazon.com, Google parent Alphabet and Facebook parent Meta Platforms have seen their stocks slide an average of 11% from their record highs reached in early July. That compares with a gain of nearly 4% over the past month for the S&P 500 Equal Weighted Index. The four tech giants are dumping record amounts of capex into AI, which hasn’t yet grown into a significant enough revenue source to merit disclosure by any of them.

Microsoft actually comes the closest in this regard. The company said Tuesday that AI services contributed 8 points to Azure’s revenue growth for the June quarter, compared with a 7-point contribution in the March quarter. The company said on its call Tuesday that its recent shortfall in cloud revenue was mostly due to weakness in a few European territories. It also said it expects Azure growth to pick back up in the December quarter—a disclosure that helped moderate some of the stock’s losses following the report.

But the spending on AI will continue to garner outsize interest from investors, given its outsize impact on the cash-flow statement. Microsoft’s total capital outlay with leases equated to nearly 23% of revenue for the just-ended fiscal year compared with an average of 14% over the previous five years. Chief Executive Officer Satya Nadella said on Tuesday’s call that Microsoft has the “demand signal" to justify those investments and can always scale back plans to fill up data-center infrastructure with servers—thus saving on expensive components such as Nvidia’s chips—if that signal changes. The AI spending wars are far from over.

Write to Dan Gallagher at dan.gallagher@wsj.com