Will Someone Finally Blink in the AI Spending War? — Heard on the Street — WSJ

By Dan Gallagher

Big tech reining in its AI spending may be a tantalizing prospect for some. It would also be a costly one.

That doesn't seem in the cards yet. Second-quarter reports coming later this month will likely show another period of blowout AI investments. Wall Street analysts estimate that combined capital spending by Google, Microsoft, Amazon.com and Meta Platforms surged 74% year over year to hit $168 billion in the June-ending quarter, according to consensus estimates from Visible Alpha.

This spending is crimping both the free cash flow and stock prices of those four companies; only Google-parent Alphabet has managed to outperform the S&P 500 this year.

But there are also some signs that AI's big spenders are looking for more ways to at least rationalize their investments. Before SpaceX went public last month, its xAI business signed a major deal to effectively share its computing capacity with Anthropic — for $1.25 billion a month.

SpaceX hasn't typically been counted among the "hyperscale" tech firms so named for their computing networks. But Elon Musk's rocket company spent $12.7 billion in capital expenditures on its AI division last year — triple what it spent on the rocket business — and analysts expect more than $37 billion to go out the door this year to that aim, according to Visible Alpha.

Now Meta may be getting in on that action. Bloomberg reported last week that the social-network giant is developing a cloud-computing business using the extensive AI network it has built out.

Meta would be very late to that industry; Amazon, Microsoft and Google have all been selling cloud services to businesses for well over a decade. But Bernstein Research analyst Madison Rezaei says the scale of Meta's network already "easily rivals cloud provider footprints." She estimates the company has about 20 gigawatts of computing capacity now with an additional 14GW coming online over the next few years.

Renting out some of that capacity would effectively confirm that Meta has overshot in its build-out. Founder and Chief Executive Mark Zuckerberg said as much at the company's annual shareholder meeting in late May. "We haven't done that yet because we think that we have a use for the compute," Zuckerberg said, in response to an investor's question about building a cloud service. "But obviously, if we get to a point where we feel that we have overbuilt, then that is an option that we have."

The big question would be whether renting out excess capacity is a short-term offset to continued mega-spending, or a sign that such spending is about to recede. Meta is a smaller company than Amazon, Microsoft and Google, but it has been the most ambitious in its AI investments. Zuckerberg has built up a division called Meta Superintelligence Labs in a push for the social network to be the first to develop a supercharged form of AI. Meta expects to spend well over half its revenue this year on capital investments, which will likely take its free cash flow into negative territory for the first time in its life as a public company.

The prospect of any of the megacap tech giants scaling back their AI capex is a worrisome one for tech investors broadly. AI spending has pumped up the business of chip companies, makers of servers and other tech hardware as well as producers of memory chips and data storage systems. That in turn has sharply boosted their relevance to the market at large. The chip companies alone in the S&P 500 now make up about 18% of the blue chip index's total market cap compared with about 5% five years ago, according to data from S&P Global Market Intelligence.

Most analysts doubt that Meta plans to actually scale back its spending. "Meta is not stepping away from the AI race; it is turning early, aggressive capacity commitments into a strategic value creation option," wrote Brent Thill of Jefferies. Still, the idea that the company has excess capacity at this stage of its AI cycle raises eyebrows. Justin Patterson of KeyBanc Capital said "it is conceivable that the scope of MSL's ambitions have narrowed vs. Meta's original AI goals when it began the capex cycle."

In any case, investors who have been watching the AI investment cycle closely aren't taking many chances. AI-exposed stocks fell hard after the Bloomberg report, with the PHLX Semiconductor Index sliding 11% over a two-day period as major chip names like Nvidia, Broadcom, Advanced Micro Devices and Intel have all fallen. Memory companies have fared even worse; SK Hynix and Micron each lost 17% and 15%, respectively, in that time. Broad selling across tech cost the Nasdaq nearly 2 percentage points over two days. Caterpillar, the second-largest Dow industrials component with a business selling generators for data centers, shed 10% over a two-day period.

The coming round of earnings reports will give the four so-called hyperscale companies a chance to signal future spending intentions. Based on their own prior projections, combined capital expenditures by Google, Amazon, Meta and Microsoft is expected to hit $710 billion this year. But even taking that to an astounding $1 trillion in 2027 would represent a growth rate of nearly half of what's expected this year.

Investor euphoria for the AI spending race could be tripped up simply by the law of very large numbers.