Alphabet’s and Microsoft’s quarterly results have sent their respective shares in opposite directions. Alphabet’s stock is up about 6% in morning trading, while Microsoft’s is off a little more than 3.6%.
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It’s not too useful to compare the two companies’ overall performance given their varied product lines and the different economic conditions they have to navigate. But when it comes to AI-related costs and revenues, they share enough surface area that their comments are worth comparing.
This earnings season, we’re keeping an eye out for two big indicators: AI costs and AI revenue.
Growth driven by AI will be the metric to watch this earnings cycle
We’re several quarters into the generative AI era, and we’ve seen ample enthusiasm, significant improvement in the underlying tech, and large private-market investments. Analysts and investors, however, are studying companies with fingers in the generative AI pots for signs of adoption and whether it’s actually helping them increase their revenue.
However, Alphabet’s and Microsoft’s results clearly indicate that the costs are high if you want to stay on the leaderboard in the modern AI arena. As for the resulting revenue, it’s starting to accrete but it largely remains something to look forward to.
In fewer words: All that AI-related work at these two companies will more likely impact results in the next few quarters than it has proved thus far.
Still, Microsoft and Alphabet believe strongly that companies will spend to buy their tech and that they are laying the foundation for more growth. This morning, we’re reading earnings materials and transcripts of Microsoft’s and Google’s earnings calls to glean tidbits and hone our perspectives. To work!
Gotta spend to earn
Let’s start with costs, since they provide a decent look at what went down this quarter.
It seems there’s been massive investment in hardware to build the data centers needed to handle AI compute workloads. Alphabet discussed its AI hardware setup during its call, saying that it provides “AI supercomputer options with Google TPUs and advanced Nvidia GPUs, and recently launched new A3 AI supercomputers powered by Nvidia’s H100.”
Buying, building and installing all that silicon does not come cheap. Here’s how Alphabet’s outgoing CFO, Ruth Porat (she has a new role at the company), described the spending on the earnings call:
Finally, as it relates to capex in Q2, the largest component was for servers, which included a meaningful increase in our investments in AI compute. . . . We expect elevated levels of investment in our technical infrastructure increasing through the back half of 2023 and continuing to grow in 2024. The primary driver is to support the opportunities we see in AI across Alphabet, including investments in GPUs and proprietary TPUs, as well as data center capacity.
Alphabet also said that slower office setups and some delays in data center projects had limited its capital expenditures in the quarter, so we could likely see more spending in the coming quarters.
Microsoft had similar notes on infrastructure costs. Pulling from two sections of its prepared remarks:
Capital expenditures, including finance leases, were $10.7 billion to support cloud demand, including investments in AI infrastructure. . . . To support our Microsoft Cloud growth and demand for our AI platform, we will accelerate investment in our cloud infrastructure. We expect capital expenditures to increase sequentially each quarter through the year as we scale to meet demand signals.
For reference, Microsoft spent $8.7 billion a year earlier.
The company also noted it is spending to increase capacity for both AI-related Azure workloads and non-AI related demand. This is good to remember so that we do not ascribe most, if not all, infra-related capital expenditures by public cloud providers to investments in AI. The cloud is still growing, and that business requires money as well.
Summing all that up: Building the resources to power all that AI work is showing up in these companies’ cash flow statements today.
But what about revenue? And what are they predicting for the days ahead?
How about demand?
Tech companies often talk about how a customer is using their software during their earnings calls. This exercise, while mind-numbingly boring, does serve a purpose, one of which is to reframe technical jargon to help people understand what is really being sold or used.
We’ll avoid boring you to sleep this morning, though, and instead scrutinize Alphabet’s and Microsoft’s comments on the demand they’re seeing.
Starting with Alphabet:
Today, more than 750,000 Workspace users have access to the new [AI] features in preview. . . . More than 70% of gen AI unicorns are Google Cloud customers, including Cohere, Jasper, Typeface, and many more. . . . We are seeing strong demand for the more than 80 models, including third-party and popular open source in our Vertex, search, and conversational AI platforms, with the number of customers growing more than 15x from April to June.
Microsoft has similar notes:
We are also seeing increasing momentum with Azure Arc, which now has 18,000 customers, up 150% year. . . . More than 11,000 organizations across industries. . . . Nearly 90% of GitHub Copilot sign-ups are self-service, indicating strong organic interest and pull-through. More than 27,000 organizations, up 2x quarter over quarter, have chosen GitHub Copilot for Business to increase the productivity of their developers. . . . And four months ago, we introduced a new pillar of customer value with Microsoft 365 Copilot. We are now rolling out Microsoft 365 Copilot to 600 paid customers through our early access program. . . . More than 1 million organizations now count on our comprehensive AI-powered solutions to protect their digital estate across cloud and endpoint platforms, up 26% year over year. . . . To date, Bing users have engaged in more than 1 billion chats and created more than 750 million images with Bing Image Creator, and Microsoft Edge took share for the ninth consecutive quarter.
Why chew through all of that before we get to the more interesting and concrete bits about revenue? Because those metrics and results indicate where tech platforms expect AI to manifest in their product lines, and it seems they see it blossoming literally everywhere.
Generative AI and its resulting services are no small potato.
Playing the long game
Lots of spending and strong early demand signals are good indicators. But what about cold, hard revenue growth?
Asked by an analyst if Alphabet is seeing any uptick in AI spending in the present quarter and coming periods, here’s what the company’s CEO Sundar Pichai had to say:
[I]t is an exciting moment overall in Cloud because there is definitely a lot of interest from customers on AI, and they definitely are engaging in many more conversations with us. So, I would say, without commenting on the short term, but when I think about it long term, I view the AI opportunity as expanding our total addressable market and allows us to win new customers. You know, scale of investments that we can directly bring to cloud now.
As I said earlier, we have over 80 models across Vertex, enterprise search, and conversational AI. And we are taking all of them, translating it into deep industry solutions. So I’m excited about it. Second, it gives us an opportunity to upsell and cross-sell into our install base.
The fact that Pichai is avoiding talking too much about short-term results is a pretty clear signal that Alphabet expects revenue from generative AI projects to land more heavily in the future than in the near term. There was some indication of an increase in demand as well: Porat said, “In the second quarter, GCP growth was above the growth rate for [Google] cloud overall.” Analysts most likely welcomed that bit of data.
Still, there isn’t much concrete information here.
We got a bit more from Microsoft. The company said its cloud business was helped by its generative AI efforts:
Azure and other cloud services revenue grew 26% and 27% in constant currency, including roughly one point from AI services as expected.
And the company expects the lift from AI to double in the current quarter:
In Azure, we expect revenue growth to be 25% to 26% in constant currency, including roughly two points from all Azure AI Services. Growth continues to be driven by our Azure consumption business, and we expect the trends from Q4 [calendar Q2 2023] to continue into Q1 [calendar Q3 2023].
What about revenue from the AI products not related to infrastructure — things like the various “copilots” launching across Microsoft’s enterprise software products? Here’s Microsoft CFO Amy Hood:
[W]hat we’re really pointing to is there’s a process here. We see the demand signal’s quite strong. It remains strong. I’m thrilled with all the product announcements we’ve made.
I’m thrilled with them moving to preview and then moving to GA. They absolutely are expansive in terms of addressable market. . . .
And then revenue is an outcome. But . . . the demand signal requires the capital expense and then creates the opportunity. And that’s why I think in some ways, we’re spending a little more time talking about some of that investment because it is the demand signal.
In response to a question about Office 365 Copilot, Hood described its future revenue impact:
I think maybe I’ll start with the process we have when we release new products. And I absolutely understand we are excited, too, by the demand signal, the customer reaction, really the requests we’re getting to be in the paid preview. It’s all encouraging.
As you know, last week, we announced pricing; then we’ll continue to work through the paid preview process, get good feedback. Then we’ll announce the general availability date; then we’ll get to the GA date. Then we’ll, of course, be able to sell it and then recognize revenue. That is why I continue to say that I am just as excited as everyone else about this, and it should be more H2-weighted.
Microsoft has a process that it uses to bring new products to market: previews, paid previews, pricing, feedback and general availability. That last point is when revenue starts flowing in, and Microsoft expects that AI-driven revenue to land more in the first two quarters of 2024 than in the rest of calendar 2023.
In a nutshell: Alphabet and Microsoft are spending heavily on hardware to support generative AI workloads. They’re also seeing their early products that take advantage of new AI methods being adopted quickly. The revenue from those efforts, however, is just starting to pick up, and more is expected in the future.
No one likes to wait and see, but it’s clear that Microsoft and Google are confident that the demand they’re seeing today will convert to gobs of revenue tomorrow.
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