Key Points
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Bloomberg said on Nov. 5 that Microsoft has tightened oversight of some outside data center projects.
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Microsoft’s free cash flow in the last four quarters was around 23% lower than a year before.
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Microsoft had around $365 billion in leases, mainly for data centers, that hadn’t begun yet as of Sept. 30.
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Microsoft (NASDAQ:MSFT) might be getting choosier about where its artificial intelligence (AI) computing power comes from.
On Nov. 5, Bloomberg said that the software giant has tightened oversight of some projects from neoclouds (firms that rent out AI computing capacity), including Nebius Group, IREN (NASDAQ:IREN), and the privately held Nscale. Microsoft is backing away from projects it finds risky, according to the report. And the Financial Times reported the same day that Microsoft won’t exercise an option to more than double the size of its Nscale deal at a Texas data center. Microsoft hasn’t confirmed either report.
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IREN said on Nov. 5 that a customer-requested design change and vendor timing pushed its goal of over $4 billion in annualized revenue into early 2027. Its quarterly filing says Microsoft asked for a network design change across the deployments IREN is delivering under their agreement.
The stock trades near $535 as of this writing, about 4% below its Nov. 4 record close of $555.80. A slower pace of outside deals may sound like relief for Microsoft’s shrinking free cash flow. I’m not sure it is.
Image source: Getty Images.
Free cash flow is still falling
Microsoft‘s spending has climbed far faster than the cash its business brings in. During its fiscal 2027 first quarter (which ended Sept. 30, 2026), cash from operations rose 29% year over year to $58 billion. But cash paid for property and equipment was $39.4 billion, more than twice the year-ago amount.
Sure, adjusted earnings per share still grew 18% year over year for the quarter.
Free cash flow (cash from operations minus cash spent on property and equipment) is another story. It was around $60 billion over the last four reported quarters, down from about $67 billion for fiscal 2026 and about $78 billion in the four quarters ended September 2025. That’s a fall of about 23%, and the decline hasn’t stopped.
“To complement cash generated by the business and preserve financial flexibility, we will access additional sources of funding when we believe it is attractive to do so,” CFO Amy Hood said on the company’s fiscal first-quarter earnings call on Oct. 28.
A day later, Microsoft agreed to sell $25 billion in notes.
Would renting less help?
Not right away, I think.
Much of that outside capacity comes through leases. Microsoft includes the full principal value of a finance lease in its capital expenditures when the lease begins, and finance leases made up $7.4 billion of the $45.2 billion it reported for the fiscal first quarter. But the cash for a lease is paid over many years.
So a dollar of rented capacity can weigh much less on this year’s free cash flow than a dollar of chips and buildings Microsoft buys outright.
And according to Bloomberg, Microsoft is focused on expanding its own data centers instead of adding neocloud deals. If more money goes there, the short-term hit to free cash flow may grow. Management already expects capital expenditures to pass $50 billion in the fiscal second quarter and to accelerate after that.
Showing how big these commitments have gotten, Microsoft had $364.6 billion in leases that hadn’t started as of Sept. 30, mostly for data centers. A year before, it had $106.2 billion. Still, the total climbed only around $35 billion in the September quarter, after rising over $130 billion between March and June (the change also reflects leases that began). Microsoft might have already been signing fewer new leases before the reports came out.
The price still looks too high to me
Demand doesn’t seem to be the problem. Azure revenue rose 48% year over year in the fiscal first quarter, and management expects 49% to 50% growth in constant currency in the fiscal second quarter.
The biggest problem is the price. Microsoft’s adjusted earnings for the last four quarters were $18.04 a share, so shares cost around 30 times adjusted earnings at $535. For a business growing earnings so fast, that price-to-earnings ratio is arguably fair. But its market cap of around $4 trillion is about 66 times the free cash flow it produced over the same stretch.
Does a pickier Microsoft make the stock a buy? I personally don’t think so. Sure, it might wind up with lower risk linked to smaller partners. But it doesn’t close the gap between earnings and cash, and it could widen it for a while if Microsoft builds more of its own capacity.
In late October, I said I’d want to buy the stock closer to $465. These reports don’t change that for me.
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Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool has a disclosure policy.
