Investors are growing increasingly worried about whether the massive amounts of money being spent on artificial intelligence (AI) infrastructure will ever pay off. This is a fair question.
Tech giants' management teams will tell investors that AI is a must-invest space, and assert that the risk of underspending and being left behind is far greater than the risk of overspending. Still, data center companies are pouring hundreds of billions of dollars into their buildouts, and investors aren't going to tolerate these sorts of capital expenditures indefinitely if there are no returns on investment in sight.
However, some AI hyperscalers are actually making money from AI right now, and there is a clear pathway to making more. How is Microsoft (MSFT +2.38%) doing it? Let's take a look.
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Microsoft is integrating AI throughout its products
There are two primary ways Microsoft is making money from AI: Copilot and Azure.
Let's start with Copilot, Microsoft's AI tool that it has embedded into nearly every Microsoft Office product. Subscribers must pay extra to access this add-on, which has allowed Microsoft to boost its revenues from its core software offerings. However, it's far less exciting than Azure.
Azure is Microsoft's cloud computing division, which is seeing strong growth as a result of increasing AI demand. Azure grew its revenue by 39% year over year in the fourth quarter, and that growth rate would have been even higher if Microsoft had leased more of its new computing capacity to external customers rather than dedicating it to internal use.
NASDAQ: MSFT
Key Data Points
The idea behind cloud computing is fairly simple: Microsoft builds excess computing capacity and then rents that out to customers that need it. Most companies lack the resources and expertise necessary to build their own AI data centers. So, they are perfectly content renting from Azure. Furthermore, most clients don't want to keep an asset like a data center on their balance sheet.
Azure is a usage-based or subscription-based service; either way, Microsoft makes more money as its service gets used more. As AI demand rises, so will Microsoft's revenue. Currently, Microsoft is in the process of expanding its capacity so it can fulfill a massive $625 billion backlog for AI computing. This is what's spurring Microsoft to spend more on AI computing capacity, as what is already online isn't close to what would be needed to run an AI-first economy.
However, the revenue it will generate over the long term from the Azure business will far outpace what it's spending, making Microsoft's spending a good idea and the stock a smart investment, as long as you stay focused on the long term.
