Microsoft's cloud growth, cash flow offer respite from AI spending fears

By Deborah Mary Sophia, Aditya Soni and Stephen Nellis

Oct 28 (Reuters) - Microsoft ‌on Wednesday forecast fiscal second-quarter cloud ​growth and overall ​sales that beat Wall Street estimates, sending shares up more than 5% in after-hours trading.

The forecast came after Microsoft had earlier beaten expectations for first-quarter cloud revenue, offering fresh evidence that its hefty AI investments were paying off as Wall Street grows increasingly wary of Big Tech's debt-fueled spending.

The software and cloud company also generated $18.6 billion ‌in free cash flow in its fiscal first quarter ended September — some $10 billion more than analysts expected — as capital spending came in below the company's ⁠own forecast and Microsoft's Azure cloud computing business surged 48%.

Microsoft said it expects second-quarter Azure growth of 49% to 50%, above analyst estimates of 47.6%, according to Visible Alpha data. The company forecast overall sales of $96 billion to $97.1 billion, above estimates ‌of $95.6 billion, according to LSEG data.

That financial firepower set ‌Microsoft apart from rivals such as Alphabet and Meta, whose heavy AI investments have squeezed free cash flow and increased their reliance on borrowing. Alphabet reported negative free cash flow of $9.07 billion in the third quarter as capital spending jumped, overshadowing a doubling of its cloud sales and sending its shares down 8% in extended trading.

Microsoft shares have risen about 9% so far ​this year, through Wednesday's close. Its five-year credit default swaps — a measure of perceived default risk — remain the tightest among the largest tech companies, according to Truist, even as spreads have widened across much of the AI trade.

The results also show Microsoft capitalizing on corporate demand for AI, easing fears that the technology threatens its software empire and that its AI fortunes are too ⁠closely tied to unprofitable OpenAI.

On a conference call with analysts, Microsoft CEO Satya Nadella said that "the shiny-object stuff is waning" in the AI market, with a broad set of Microsoft customers now making plans for spending over a decade or more, rather than ​a handful of large customers making quarter-by-quarter purchases.

"That's what I've been waiting for, as opposed to four customers who buy a lot of capacity from you, and you can show a few quarters of growth," Nadella said. "That's not a business, as far as I'm concerned. I want the breadth."

Nadella ​also said the company is seeking to give customers a range of AI options, some of them at lower ‌cost than cutting-edge AI models. The company is trying to make its Copilot products more useful with each model release by "consolidating the frontier gains for broad deployment," he added.

STRONG AZURE GROWTH

"Microsoft's first-quarter report was about as clean as it gets for a company this size," said Jesse Cohen, senior analyst at ⁠Investing.com. "After Meta's and Alphabet's numbers revived AI-spending anxiety, this is the counterweight. Demand still exceeds supply, the commercial backlog is enormous, and returns are finally showing up in earnings and overall revenue."

Last month, Microsoft said it would disclose Azure revenue in dollars, instead of just growth rates, offering a clearer picture of how its cloud business stacks up against rivals Amazon Web Services and Google Cloud.

Revenue at Microsoft's Azure cloud computing business grew to $33.17 billion in ⁠the quarter, topping Visible Alpha's estimate of $32.84 billion. Overall revenue rose by a fifth to $92.28 billion, and an adjusted profit of $4.89 per share beat an average estimate of $4.73 a share.

LOWER SPENDING THAN FORECAST

Capital expenditure for the quarter ​rose to $45.2 billion from $34.9 billion in the year-ago period, but came in below the company's own projection of $50 billion. So far in calendar 2026, Microsoft's capital expenditure has been $118.1 billion, which means it would have to spend $56.9 billion in the final three months of the year to hit its own forecast of $175 billion given in July.

Jonathan Neilson, Microsoft's vice president of investor relations, attributed the lower-than-expected capital expenditure to delays rather than any changes to ‌the company's underlying spending plans.

"We did see some third-party capacity deliveries that we expected in first quarter were actually delayed," Neilson said.

Earlier on Wednesday, hyperscaler Oracle said it expects capital spending to peak this fiscal year and next, but pledged to raise no more than $20 billion in additional financing ‌for AI through fiscal 2030.

Overall, Big Tech is expected to pump more than $700 billion this year into building data centers and securing the hardware and energy needed to develop and run AI technologies.

While faster revenue growth at these ⁠companies indicates their bets could be paying off, concerns over the cost of ‌financing the outlay have heightened over the past few weeks.

Shrinking ​cash flows and rising debt loads at US tech companies, including recent stress at neocloud company CoreWeave as well as record-high costs to insure Meta's debt against default, have added to market turmoil.

(Reporting by Deborah Sophia and Aditya Soni in Bengaluru and Stephen Nellis in San Francisco; Editing by Diti Pujara, Sayantani Ghosh, Matthew ‌Lewis and Lincoln Feast.)

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