An AI-induced margin squeeze is coming for hyperscalers

The biggest US tech companies doubled, tripled, and quadrupled down on their plans to spend billions on their AI build-outs.

By and large, markets don’t seem too impressed by that strategy.

“Price reactions suggest growing concerns around monetization versus capex for hyperscalers, with Meta the only one rising on earnings,” Bank of America strategists Ohsung Kwon and Savita Subramanian wrote about a quartet that includes Microsoft, Amazon, Alphabet, and the aforementioned Zuckerberg-run social media company.

We’ve remarked how these companies’ freewheeling spending isn’t fully accounted for in the highest-profile financial metrics that move markets during earnings season. But even so, the way capex costs show up in the income statement is slated to exert meaningfully negative pressure on profit margins, per the strategists.

“Margins are expected to be hit by the capex cycle going forward,” they wrote. “Assuming 10 years of useful life, we estimate that 2025-26 estimated consensus capex of $612 billion translates into an incremental 160 basis point EBIT margin hit in 2026 via increased D&A costs vs. the 4Q24 run rate.”

D&A — depreciation and amortization — costs are the capital that you effectively “use up” in the production process or is rendered obsolete. Without getting too far into the weeds, there is a concern that the “useful life” of a lot of these AI-related outlays might be a bit shorter than normal due to the seemingly rapid march of technological progress.

Amazon CFO Brian Olsavsky validated some of these concerns in an earnings call last week.

“We completed a useful life study for our servers and networking equipment and observed an increased pace of technology development, particularly in the area of artificial intelligence and machine learning,” he said. “As a result, we’re decreasing the useful life for a subset of our servers and networking equipment from six years to five years, beginning in January 2025.”

That’ll leave about a $700 million hole in operating income this year.

And yes, these outlays have been leaving a mark on the statement of cash flows, and the sell side has been pushing back the timetable for when relief is coming. Per the analysts, Wall Street was looking for hypserscalers’ capex as a share of operating cash flow to be on a glide path lower as of September. Now, it’s expected to plateau at a fairly high level.

“AI monetization remains a question mark,” they added.

The section of the report concludes with a sobering pair of charts:

• Companies that spend way more on capex than their peers tend to underperform; and

• Semiconductor companies most levered to the AI boom have seen their relative outperformance of the S&P 500 wane as soon as there was some visibility into a slowdown in the growth rate of business investment by these hyperscalers.