Microsoft’s AI Investment Pushes Cloud Services Forward, Alphabet Struggles to Compete

Google parent Alphabet’s cloud business suffered as longtime rival Microsoft surged in the September quarter, showing early signs that the Windows maker’s investment in artificial intelligence was paying off.

Alphabet shares were down 7% in after-hours trading on Tuesday. Microsoft up 5 percent.

The drop in Alphabet’s shares, despite beating Wall Street estimates for overall earnings and sales, showed investors wanted it to make gains in artificial intelligence and show it remained competitive against Microsoft’s Azure and Amazon.com’s AWS cloud businesses.

“While an individual quarter is not a significant trend, this quarter’s cloud results suggest that Azure is gaining ground on its competitors,” said Bob O’Donnell, principal analyst at TECHnalysis Research.

“Furthermore, it may be that Microsoft’s very strong communication on its Copilots and GenAI technologies will lead companies to consider them more seriously.”

Microsoft has emerged as a pioneer in artificial intelligence, thanks in large part to its significant investment in startup OpenAI, maker of the hit product-generative AI chatGPT.

Microsoft has integrated OpenAI’s technology throughout its product catalog, its search engine Bing, its workplace productivity software Microsoft 365 and its software coding platform Github.

Alphabet has also implemented artificial intelligence in dozens of its products, such as its flagship Pixel phones, and recently experimented with adding generative artificial intelligence to its search engine. Earlier this year, the company released a generative AI chatbot called Bard to compete with ChatGPT.

Microsoft CFO Amy Hood said on a conference call with analysts that higher-than-expected AI spending was the reason for the 3 percentage point increase in its cloud business.

Alphabet has prioritized earning AI startups as clients for its cloud division, while Microsoft has relied on its existing relationships to secure larger clients. That strategy paid off, said Krishna Chintalapalli, portfolio manager at Alphabet and Microsoft investor Parnassus Investments.

AZURE DAZZLES

Data from LSEG showed revenue at Microsoft’s Intelligent Cloud unit, which includes the Azure cloud computing platform, rose to $24.3 billion, compared to analysts’ estimates of $23.49 billion. Azure’s revenue grew by 29% more than market research firm Visible Alpha’s 26.2% growth estimate.

RBC Capital Markets has previously estimated that Microsoft will have more than $3 billion in revenue from generative AI offerings this fiscal year.

In contrast, revenue from Google’s cloud business rose 22.5% to $8.41 billion in the quarter ended Sept. 30, its slowest growth in at least 11 quarters. That missed the average Wall Street estimate of $8.62 billion.

Microsoft has promised to spend aggressively on AI to meet demand. The company said on Tuesday that public investment in the first quarter was $11.2 billion, up from $10.7 billion in the previous quarter, which itself was the largest spending since at least 2016.

Microsoft executives say that number is likely to increase each quarter this fiscal year, pushing the company to spend more than $44 billion.

Google’s capital expenditures increased 10.7% to $8.06 billion in July-September from a year ago.

“For Microsoft, these are absolutely phenomenal numbers, given the cautious macroeconomic outlook and the volatile IT spending environment. Quite surprising to see strong growth acceleration in the Azure Cloud segment, which is clearly driven by demand for AI services,” said Global X analyst Tejas Dessai.

Amazon is scheduled to report quarterly on Thursday, and analysts expect AWS sales to grow 12.4 percent. Amazon shares fell 1.4 percent in after-market trading on Tuesday.