Microsoft Is Reportedly Getting Pickier About AI Data Center Deals. Is the Stock a Buy Now?

Microsoft (MSFT) may be becoming more selective when it comes to acquiring AI computing power. Bloomberg reported on November 5 that the tech giant tightened oversight of certain projects from neocloud providers, including Nebius Group, IREN, and the privately-held Nscale. Microsoft is said to be distancing itself from projects it deems risky.

The Financial Times also claimed Microsoft would not exercise an option to expand its deal with Nscale, located in a Texas data center. However, neither report has been confirmed by Microsoft. IREN stated that a customer-requested design change and vendor timing pushed its goal of generating $4 billion in annualized revenue into early 2027.

Microsoft's stock is currently trading near $535, slightly below its record close of $555.80 on November 4. Despite Microsoft's strong cash flow from operations, which grew by 29% year-over-year to $58 billion during its fiscal 2027 first quarter, its capital expenditures have surged rapidly. In the same quarter, cash paid for property and equipment amounted to $39.4 billion, more than double the prior year's amount.

While adjusted earnings per share grew by 18% year-over-year, free cash flow, which is cash generated from operations minus capital expenditures, fell by about 23% from $67 billion in fiscal 2026 to $60 billion over the last four quarters. Microsoft's CFO, Amy Hood, mentioned that they will explore additional sources of funding when an attractive opportunity arises.

The company has also been focused on expanding its own data centers rather than increasing neocloud deals. This shift in strategy may lead to a higher short-term impact on free cash flow. Microsoft had $364.6 billion in leases that hadn't begun as of September 30, primarily for data centers, which is a significant increase from $106.2 billion a year prior.

Despite this, the total increased by $35 billion in the September quarter, after rising over $130 billion between March and June. Microsoft's Azure revenue rose by 48% year-over-year in the fiscal first quarter, and management expects 49% to 50% growth in constant currency in the fiscal second quarter. However, the stock's price-to-earnings ratio of around 30 times, based on adjusted earnings of $18.04 a share, is relatively high compared to the market cap of approximately $4 trillion, which is about 66 times the free cash flow generated in the same period.

The reports of Microsoft's pickier approach to data center deals may not necessarily make the stock a buy, as it could still face challenges closing the gap between earnings and cash and potentially widening this gap if Microsoft increases its own capacity.