Microsoft: early investment in generative AI pays off

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Generative artificial intelligence is a data-intensive business. The quickest and easiest way to scale up processing power is via cloud computing. That is very good news for Microsoft, the world’s second-largest vendor of cloud services.

On Tuesday, Microsoft demonstrated just how strong global demand for compute power has become. Revenue in the Intelligent Cloud unit jumped 19 per cent in the three months to September 30, aided by a cloud partnership with Oracle. For a company with a market capitalisation of $2.5tn to expand the largest segment of its business at this pace is noteworthy. Compare it to Alphabet, where Google Search revenue rose 11 per cent in the last quarter. Or Apple, where iPhone sales are growing at 2.5 per cent.  

Rapid cloud expansion meant Microsoft exceeded predictions of slowing growth across the business. Even better, its existing investment in generative AI start-up OpenAI, home of ChatGPT, has allowed it to add AI to its services while simultaneously slowing down spending on R&D, which rose less than 1 per cent in the quarter. If companies want to integrate OpenAI’s tools they can do so via Microsoft’s cloud computing platform Azure. OpenAI has also enabled Microsoft to build AI assistance into products such as Word and Excel. 

Before AI, one of Microsoft’s biggest bets was in gaming. After a nearly two-year fight, its $75bn deal to buy Activision Blizzard has been approved by US and UK regulators. But the deal was born in a different time and now garners markedly less interest. Chief executive Satya Nadella left it to the end of his prepared speech to investors, who asked no follow-up questions. The deal’s contribution pales beside cloud. It will eat up a large portion of Microsoft’s $144bn in cash, equivalents and short-term investments, too. So would a nearly $29bn bill for back taxes that has been demanded by the US Internal Revenue Service. 

Still, high cash generation will quickly replenish the total. Free cash flow rose 22 per cent to $21bn in the last quarter. In the trillion-dollar company club, only Amazon trades at a higher price to earnings multiple than Microsoft. Cloud expansion merits that position.