Why Microsoft's investment in AI should start to pay off in 2025

MW Why Microsoft's investment in AI should start to pay off in 2025

By Ryan Shrout

Hardware development and software support makes the tech giant a formidable contender

This article is part of a series where tech-company analyst Ryan Shrout evaluates tech-industry leaders' prospects for 2025. Some of this commentary is based on assumptions of product execution, market adjustment and competitive displacement. It is not a comprehensive analysis of a full-year outlook.

The disruptive elements of the U.S. Stargate program and the release of the Chinese artificial-intelligence company DeepSeek has put more critical eyes than ever on major AI players like Microsoft $(MSFT)$.

In its earnings report after the close on Wednesday, Microsoft reported a 12% increase in revenue year on year, and improvements in margin and EPS. Microsoft Chief Executive Satya Nadella told analysts there would be no slowdown in infrastructure investment, tossing off fears that DeepSeek would derail the AI progress that U.S. Big Tech has been making. But even with a 31% increase in revenue for Microsoft's Azure group, Wall Street expectations were a couple points higher and the stock was hit hard in Thursday trading.

Investors shouldn't be shortsighted. Microsoft's Azure cloud platform is poised for substantial growth in 2025, driven by several factors. Azure's support for hybrid and multi-cloud enterprise integration strategies offers businesses flexibility and resilience, potentially making it the preferred choice for organizations seeking adaptable cloud solutions. The Azure AI Foundry provides a new architecture for enterprise AI applications and developers, promising more around services and AI model integrations than just access to bare hardware or cloud instances. This will be a key differentiator for Microsoft against rivals with fewer internal development resources.

Collaborations with Nvidia $(NVDA)$ and other industry leaders have brought advanced GPUs like the GB200 "Grace Blackwell" to Azure, ensuring top-tier performance for AI workloads. Microsoft has been one of, if not the lead partner for Nvidia on these new architectures, and this should continue in 2025. Having access to the latest and greatest silicon and solutions from the AI compute leader is critical to keep Azure a top-of-mind leader in the hyperscaler space.

Microsoft's development of custom-designed computing chips, including the Maia chip for large language models and the Cobalt CPU for general cloud services, underscores its commitment to optimizing performance and efficiency. I expect these offerings to grow in 2025, both in terms of new chips and in implementation breadth, making up a larger portion of the Azure ecosystem. This will aid in controlling margins and Microsoft's ability to differentiate to a range of potential customers in the space.

Strategic alliances with companies like Palantir Technologies $(PLTR)$ have expanded Azure's capabilities, particularly in delivering AI-based data analytics products to U.S. defense and intelligence agencies. Under the Trump administration, this could become a very profitable expansion.

The anticipated widespread adoption of AI in 2025 is expected to drive significant growth in Microsoft's consumer and commercial client product segments. The broader availability of Copilot+ PCs, now with chips available from Qualcomm $(QCOM)$, AMD $(AMD)$, and Intel $(INTC)$, are equipped with enhanced AI features and are set to stimulate a long-awaited upgrade cycle among consumers.

The integration of AI capabilities into Microsoft 365, including tools like Copilot, will enhance productivity and drive adoption across both consumer and enterprise markets. The only question is how high this can and will scale. Microsoft is clearly building the infrastructure in the cloud to support it, but convincing businesses to integrate and pay for these new services is the next step for marketing and product teams.

Microsoft's gaming division, bolstered by the acquisition of Activision Blizzard, has seen significant revenue increases. The company is expected to continue expanding its gaming ecosystem across Xbox, PC, and third-party platforms, potentially shifting focus away from specific hardware to a more inclusive gaming experience. How this impacts both the gaming division (from a revenue perspective) and the gaming market holistically has yet to be seen, but there is a chance this could be a net-negative to revenue in the short term.

This year should be pivotal in the AI landscape, with companies vying for thought leadership and innovation. As new developments slam the market with disruption like Stargate and DeepSeek, Microsoft's unique position, encompassing hardware development, software support, and services provision, makes it a formidable contender. The combination of custom hardware, such as the Maia and Cobalt chips, with advanced software platforms and AI models, positions it as a leader in delivering comprehensive AI solutions.

Risks to Microsoft's earnings

Last year, Microsoft reported revenue increase of 16%, reaching $245.1 billion, with net income rising by 22% to $88.1 billion. Massive numbers by any account, but with the heavy investment in AI infrastructure under more scrutiny than ever, the company clearly needs to show growth beyond that in 2025.

While the outlook for the year ahead is optimistic, there are still risks that could impact Microsoft. If AI infrastructure becomes commoditized, competition may shift to pricing, potentially affecting Microsoft's revenue and margins in the Azure segment. The success of AI-driven client products, such as Copilot+, depends on consumer uptake. If consumers perceive limited value or opt for alternative AI solutions, Microsoft's growth in this area could be constrained. A slowdown in market growth or heavy saturation could directly impact companies investing in AI, including Microsoft. New entrants in the hyperscaler space, such as Nvidia (with software and services) or startups like Groq, with focused product offerings, could present competitive challenges to Azure's market position.

Despite being one of the most valuable companies globally, Microsoft's price-to-earnings (P/E) ratio remains more conservative compared with other major AI players such as Nvidia or Broadcom $(AVGO)$. Microsoft's diverse revenue sources, spanning cloud services, productivity software, and gaming, provide resilience against sector-specific downturns. However, this diversification may also temper the company's upside potential compared with more specialized AI firms. But I see this as a worthwhile balance of stability and risk.

Put together, Microsoft's strategic initiatives and investments in AI, cloud services, and consumer products position it for a potentially transformative year in 2025. While challenges and risks exist, the company's comprehensive approach and diversified portfolio provide a solid foundation for sustained growth and innovation.

Ryan Shrout is the president of Signal65 and founder of Shrout Research. Follow him on X @ryanshrout. Shrout has provided consulting services for AMD, Qualcomm, Intel, Arm Holdings, Micron Technology, Nvidia and others. He holds shares of Intel.

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-Ryan Shrout

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January 31, 2025 07:45 ET (12:45 GMT)

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