If AI revenue doesn't come about as quickly as expected, large tech companies could see margin pressure and have to wait longer for returns on their massive investments
Large technology companies are pouring money into artificial-intelligence hardware purchases - and those moves are "not without risk," according to Moody's analysts.
Alphabet Inc. $(GOOG)$ $(GOOGL)$, Amazon.com Inc. $(AMZN)$, Meta Platforms Inc. (META) and Microsoft Corp. $(MSFT)$ are among those with swelling capital-expense budgets that the team at Moody's said will support data-center capacity in the years to come.
"Some of their centers cover more than 500,000 square feet - about the size of six soccer pitches - and cost upwards of $1 billion to construct," the analysts, led by Rai Joshi, wrote in a Wednesday report. The goal is to bring about new AI functions for consumers and businesses.
Hyperscale cloud providers could together spend upward of $48 billion more on information-technology budgets this year, which is a much larger increase than those seen in recent years. But as these companies accelerate their bets on AI infrastructure, there's no guarantee the trend will play out as they project.
Don't miss: Tech selloff erases $1.1 trillion of 'Magnificent Seven' market cap in five days
"If demand for AI applications by enterprises turns out lower than expected, for example, they may have to wait longer than anticipated to realize returns on their investments," the analysts noted.
Plus, as the market for AI offerings gets more competitive, that dynamic "could force pricing of AI services down, squeezing margins below those they currently enjoy from their existing core businesses such as search, software, digital advertising or existing third-party cloud services," according to Moody's.
In turn, these companies that "have generally held their margins steady," partly through cost cuts elsewhere in their businesses, may face growing pressure from investors to allocate more money toward capital returns if margins weaken, the analysts wrote, adding: "This could erode their creditworthiness over time."
It's worth noting that this spending is all "easily affordable" for Microsoft, Alphabet, Apple Inc. $(AAPL)$, Amazon and Meta, Moody's said. That's because those companies "have robust cash balances and they generate substantial free cash flow (after dividends) from their existing operations."
Aside from Amazon, which has a 1.7x leverage ratio, the other four have ratios of adjusted total debt to earnings before interest, taxes, depreciation and amortization (Ebitda) that are less than 1.0x, the Moody's team noted.
Yet Oracle Corp. $(ORCL)$ is also spending up on AI infrastructure, and its financial position is a bit different, the analysts said. "Oracle has lesser financial flexibility than its hyperscaler peers, as its cash balances have declined and gross debt has increased sharply in recent years as a result of its large share repurchases and acquisition spending."
Moody's calculates a 4.3x ratio of adjusted total debt to Ebitda for Oracle.
There's been growing concern on Wall Street about the pace of AI spending and whether the companies pouring big bucks into AI buildouts will generate enough revenue to match those investments.
Barclays analysts recently asked if companies were spending out of the "fear of missing out" - also known as FOMO - or if they were about to recognize huge AI revenue in a "Field of Dreams" situation.
"We are leaning FOMO and expect someone to flinch next year, but it's still very early for AI," they concluded.