Microsoft's significant AI investment will result in over $100 billion in data center leases.

• Microsoft's finance leases for data centers have increased to $108.4 billion.
• That's up by more than $100 billion in two years.
• Building out data centers for artificial intelligence workloads will likely put pressure on margins due to the leases being geared toward this purpose.

This month, as investors prepare for quarterly earnings, a crucial metric to focus on is finance leases.

Instead of paying for an asset in full, a finance lease allows a company to make payments over time. This is particularly beneficial for companies like Microsoft, which are investing heavily in data centers for AI workloads, as shareholders may need to adjust to large financial commitments.

In July, Microsoft reported that its finance leases for the 2025-2030 fiscal years had increased to $108.4 billion, up $20.6 billion from the previous quarter and $100 billion higher than two years earlier.

In the most recent quarter, Microsoft spent $19 billion on capital expenditures, which is a significant increase from the $14 billion spent in the previous quarter and is equivalent to the total amount spent in the entire 2020 fiscal year.

Charles Fitzgerald, a former Microsoft manager and blogger, stated that the ramp was insane.

Microsoft's lease finances will be further clarified when the company reports its fiscal first-quarter results in late October. Top tech companies, including Microsoft, have approved higher capital expenditures in the past two years to improve their performance in generative AI.

Microsoft has announced its involvement in a fund to support the construction of data centers and related energy infrastructure, primarily in the U.S. Additionally, the company has signed a 20-year power purchase agreement to restart a reactor at the Three Mile Island nuclear plant in Pennsylvania.

Caught off guard

Microsoft's higher costs in the June quarter were anticipated by those who followed finance chief Amy Hood's guidance from April. She had warned for the third time in a year that Microsoft was expecting capital expenditures to increase "significantly."

RBC Capital Markets' Rishi Jaluria was taken aback by the finance lease figure.

I consistently believe that capital leases and capital expenditures will be significantly higher than anticipated, but they surpassed my own expectations," Jaluria stated. "To be honest, I have faith in Microsoft's decision-making.

Microsoft claims to deliver the optimal combination of performance and cost when constructing data centers from scratch. However, there are instances where the company requires extra capacity urgently, and finance leases can facilitate this acquisition at a faster pace.

Since the launch of ChatGPT in late 2022, the pace has been fast-paced. Microsoft provides the computing power to OpenAI, which requires a large number of servers with graphics processing units to keep ChatGPT running smoothly.

Microsoft has recently added CoreWeave and Oracle as cloud providers, as UBS analysts noted in a September report that comments made by Hood in January suggest that Microsoft's finance leases include relationships with these providers.

Microsoft did not disclose the location of third-party cloud partnerships in its financial statements.

Jaluria stated that investors tend to overlook backlogs when it comes to capital leases. Microsoft does not provide information on when these leases will commence or how long they will persist, making them less pressing than in-quarter capital expenditures.

Nadella typically defers to Hood when analysts query about financial matters during earnings calls. However, in July, Nadella took the lead when an analyst inquired about Microsoft's strategy for forming partnerships with other cloud providers to complement its direct data center investments.

"Nadella stated that buying from Oracle is as efficient as leases they have done in the past, and sometimes even more so because the leases are shorter in duration."

Jaluria stated that investors must understand that the increase in capital expenditures and future finance leases will negatively impact profitability.

"Jaluria, with a buy rating on the stock, stated that margins are decreasing naturally. Although the cost is present, the benefits are not yet visible, and he believes it is acceptable."

Ankur Crawford of Alger predicts that 2025-2028 will be significant capital expenditure (CapEx) years for hyperscalers.