AI lesson for Microsoft and Google: Spend money to make money

Microsoft's shares were down more than 4 per cent in premarket trading on Wednesday, while Alphabet gained nearly 7%.

Artificial intelligence is expected to pay off big for tech giants including Microsoft and Alphabet someday. But expect deeper investments before gains trickle to the bottom line, the companies said on Tuesday.

Microsoft said costs rose sharply as it built new data centers to support AI and that capital expenditures will continue to rise as it buys chips from the likes of Nvidia Corp to power those data centers.

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The Windows maker's shares were down more than 4 per cent in premarket trading on Wednesday, while Alphabet gained nearly 7 per cent.

Microsoft is bearing AI costs in two ways, analysts said: to power its own products such as its forthcoming $30-a-month Copilot AI assistant, and to serve companies wanting to use its Azure cloud computing services to create AI products.

Microsoft executives said the service will start generating the bulk of its revenue in the second half of its fiscal 2024 ending June 30.

"They're buying a bunch of H100s," said Ben Bajarin, chief executive and principal analyst of Creative Strategies, referring to Nvidia's flagship chips for AI.

"You're probably going to see a similar thing with Amazon , if not this quarter then the next quarter, because both of them are the clouds that the vast majority of the market is using for training (AI systems) right now."

Alphabet, however, kept down costs, though not for long. Chief Financial Officer Ruth Porat, who will become president and chief investment officer, said delays in data center construction are why second-quarter capex was lower than expected.

"As far as AI is concerned, while Google may have spent upwards of $200 billion on AI investments over the past decade, much of that isn't necessarily appreciated by users and investors," said Scott Kessler, global sector lead for technology media and telecommunications at Third Bridge.

One advantage Google has, analysts said, is that it has its own custom chip for handling AI work called the Tensor Processor Unit (TPU), which helps lower costs.

Microsoft may be "aggressively buying Nvidia chips, given Microsoft does not have its own silicon as an alternative," said Atlantic Equities analyst James Cordwell.

But Google conceded that it will buy chips from other companies as well as using its own, and Porat said that spending could put a drag on profit and growth.

"The message on inflection point was the same," from Microsoft and Google, said Gene Munster, managing partner at Deepwater Asset Management, "but the difference was Microsoft investors wanted to see more."