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RIIQ Newsletter

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In Today’s Newsletter

• The massive amount of capital investment into artificial intelligence (A.I.) by Big Tech.

• How the AI revolution is shaping up on both sides of the Atlantic.

• Will all this investment in AI actually deliver the promised returns?

• The parallel between today’s AI capex cycle and the infamous investment bubbles of the 19th century, like the railroad and telegraph booms

• The concept of “Telco-fication,” and how it potentially applies to Big Tech.

Deep-Dive

INTRO

Across the globe, the largest tech companies, the hyperscalers of our time—mostly Microsoft, Alphabet, Meta, Amazon and Apple— are making a colossal bet on artificial intelligence (AI). 

From the heart of Silicon Valley to European shores, AI is shaping up to be the battleground where future tech empires will rise or fall. And let’s face it: when tech giants are throwing around trillions of dollars, it’s hard not to pay attention.

According to recent projections, Microsoft, Alphabet, Meta, and Amazon alone are set to spend over $1 trillion on AI infrastructure and research over the next several years.

This massive capital investment is primarily aimed at building data centers, acquiring advanced hardware like NVIDIA GPUs (see capex levels of big tech companies directly going to Nvidia on the graph below), and developing the next wave of AI-driven products and services.

But will this big bet pay off? And what about Europe—are they cashing in on this AI gold rush too? Let’s break it down and see how this AI revolution is shaping up on both sides of the Atlantic.

Big Tech’s Next Big Bet

To understand why Big Tech is investing such staggering amounts into AI, look no further than the numbers. These companies are pushing the limits of what’s possible with AI and are willing to endure hefty costs to secure their positions at the forefront of this technological revolution.

In 2024 alone, the combined capital expenditures from Microsoft, Alphabet, Meta, and Amazon are expected to surpass $189 billion, which accounts for over 20% of the S&P 500's total capex. This isn't just an isolated year of heavy spending either; AI has become a long-term game.

Microsoft, for instance, increased its annual capex by nearly 800% over the last decade, soaring from around $5.5 billion in 2014 to approximately $44.5 billion by 2024. A massive chunk of this money is funneled into building the cloud infrastructure—Azure, AWS, and Google Cloud—that will power AI’s future. Does it make you dizzy?

Alphabet is following suit, with its 2024 AI-related capex expected to exceed $50 billion. Meta, too, is raising the stakes, investing over $37 billion in AI and infrastructure. Even Amazon, primarily known for its e-commerce empire, is using AWS as a launchpad for its AI ambitions, with a projected $60 billion+ capex in 2024. Clearly, these companies are not just dipping their toes into AI—they’re diving in headfirst.

Europe’s Quiet Role in the AI Boom

It’s not all about Silicon Valley, though. European companies, particularly those in sectors like semiconductor equipment and data center construction, are positioned to be some of the biggest winners in this multi-year AI revolution. For years, European firms were seen as lagging behind their U.S. counterparts in tech innovation, but now, they’re stepping into a new role—as key players in AI’s supply chain.

The hyperscalers—Amazon, Microsoft, and Google, among others—are buying European technology and services in spades. From cutting-edge semiconductor equipment to data center infrastructure and materials, European companies are reaping the benefits of Big Tech’s enormous spending. For example, companies providing critical components for AI data centers, like ASML and Infineon, are seeing skyrocketing demand for their products. The AI boom isn’t just a one-region phenomenon; it’s global, and Europe is cashing in quietly but surely!

The ROI Question: Will AI Investments Pay Off?

Here’s the elephant in the room: will all this investment in AI actually deliver the promised returns? This is where the conversation gets interesting…

This is where the conversation gets interesting, as skeptics have been quick to point out that the hyperscalers’ AI-related revenues aren’t yet matching their staggering expenditures. Sure, AI is exciting, but some argue that the tangible revenue boost hasn’t materialized to justify the price tags—at least not yet.

In 2023, as the hyperscalers ramped up their AI spending, many investors voiced concerns. After all, with $200 billion+ in combined yearly capex, the pressure is on for these companies to start showing real returns on their investments. And while the leaders of Big Tech, like Sundar Pichai at Alphabet, have staunchly defended the long-term vision, saying, “the risk of under-investing is greater than the risk of over-investing,” it’s clear that the AI ROI remains a major question.

It’s not just about throwing money at AI. Big Tech’s balance sheets can handle the strain, no doubt. Companies like Microsoft and Alphabet collectively boast hundreds of billions of dollars in free cash flow (as you can see on the graph below with the levels of FCF for the two companies), and they’re still in a strong financial position despite their massive AI-related capex.

But the ROI narrative is important—particularly as some analysts have drawn unflattering parallels between today’s AI capex cycle and the infamous investment bubbles of the 19th century, like the railroad and telegraph booms.

The key difference? While railroads and telegraphs had clearly defined profit models, AI’s true potential remains somewhat amorphous, tied to vague promises of “productivity” and “efficiency.”

Yet, despite the skepticism, many within Big Tech are steadfast in their belief that AI is the future. And if these companies can successfully integrate AI into their core businesses—whether through cloud computing, search, or enterprise tools—then the payoff could be astronomical.

To picture this, let’s have a look on the return on total capital (ROTC) figures shown in the graph below with our favorite players. It reveals a relatively steady performance. This trend might appear puzzling, given the massive investments into AI. However, this stability in ROTC could be due to the fact that AI investments, while significant, are still in their early phases of generating concrete financial returns.

Currently, the cost of investment is absorbed into broader operational expenses, and the impact on capital returns will likely take time to materialize. AI advancements promise long-term productivity and efficiency gains, but translating these into immediate returns remains challenging.

As these companies continue refining AI applications and scaling them across industries, the benefits will potentially reflect in their financial metrics in the coming years.

CapEx Crunch: a Balance of Risk and Reward

The current wave of AI investment has sparked concerns about overinvestment, with some fearing that the hyperscalers could be digging themselves into a financial hole.

However, these tech giants don’t seem to be slowing down anytime soon. The capex spending spree continues to rise, driven by the belief that AI will become a critical business necessity in the near future.

Microsoft has perhaps the clearest capex trajectory in AI. Between 2014 and 2024, the company grew its property, plant, and equipment (PPE) by more than 10 times, increasing from roughly $13 billion to $135 billion. This surge reflects Microsoft’s long-term commitment to building the physical infrastructure needed to power its cloud and AI services. In fact, in terms of monetizing AI features and services, Microsoft appears to have the edge, with multiple different AI revenue streams. Amazon is described as being a close second in the race.

By 2028, Microsoft, Alphabet, Amazon, and Oracle are expected to have combined PPE of nearly $960 billion. For context, that’s a 75% increase from where they stand in 2024. In fact, capital expenditures as a percentage of sales for these companies are expected to climb from around 40% to nearly 50% in the coming years, mirroring the asset-heavy nature of industries like telecommunications.

This trend has led to the concept of “Telco-fication,” suggesting that Big Tech could evolve into a similar model, where constant investment in physical infrastructure is necessary to maintain business operations. This would essentially make high-intensity capital tech companies even higher in capital intensity…in terms of the level of ongoing capex needed to support operations and any competitive advantage in that space.

The need to redeploy so much earnings and FCF into capital expenditures may potentially be at the expense of shareholder value. That’s why the question of ROI is so critical to the scope of these massive investments, and these Big Tech companies will have to find good ability at striking a balance with the risk vs reward.

Read more about great companies redeploying earnings at above-average returns to increase shareholder value in our prior write-up: Great Companies Reinvest.

No Plan B: Why Big Tech Can’t Stop Investing

Here’s the thing: the hyperscalers can’t afford to not invest in AI. The nature of their business demands it. AI has the potential to change everything—from the way companies process data to the way consumers interact with technology. And in a world where AI’s importance is only going to grow, the biggest players are racing to stay ahead.

Imagine a future where Amazon or Microsoft failed to keep pace with AI developments. Not having the capacity to compete in AI could mean falling behind, losing customers, and, eventually, risking irrelevance. It’s a “do or die” situation, and Big Tech knows it.

As Amazon CEO Andy Jassy put it, “The risk of under-investing is dramatically greater than over-investing.” This sentiment is echoed by leaders across the tech landscape, all of whom recognize that staying on the cutting edge of AI is critical for their future survival.

Plus, Big Tech is uniquely positioned to handle the high costs. Unlike previous technology revolutions that required government backing or public investments (think railroads and highways), today’s tech giants are wealthier than most governments. With hundreds of billions of dollars in cash reserves, they’re able to sustain these massive capex cycles without needing outside help. In other words, they can afford to bet big on AI—and keep going even if the ROI isn’t immediately apparent.

The Heavy Transformation of Big Tech

As we look ahead, it’s becoming clearer that AI investments could reshape the financial profiles of the biggest tech companies. This concept of “infrastructure-heavy transformation” is more than just a catchy phrase—it’s a reflection of how Big Tech’s capex is increasingly aligned with that of the telecommunications industry.

For decades, telecom companies like Deutsche Telekom and Vodafone have relied on constant investment in physical infrastructure to maintain operations and grow their customer base. The same might be true for Microsoft, Alphabet, and Amazon in the AI era.

From data centers to AI-specific hardware, these investments are vital to their success. And while the returns might not come immediately, they’re betting that AI will eventually generate significant revenue streams—whether through cloud services, enterprise tools, or even consumer-facing products like Microsoft’s Copilot.

It’s a long game, and the hyperscalers are ready to play.

Conclusion: The Final Word

AI is the future—and Big Tech is going all-in.

With over $1 trillion on the line, the stakes have never been higher, but the potential rewards are equally immense. Whether it’s Microsoft building out Azure, Alphabet supercharging Google Cloud, Meta driving user engagement, or Amazon revolutionizing e-commerce with AI, one thing is certain: AI is reshaping the tech landscape, and the companies that invest today will be the ones to reap the benefits tomorrow.

As for Europe, don’t count them out. While the spotlight might be on Silicon Valley, European companies are quietly playing a crucial role in the AI supply chain, providing the essential tools and infrastructure that make the AI revolution possible. Whether in semiconductor equipment or data center construction, Europe is poised to be one of the big winners in this global AI arms race.

So, is it risky? Sure. But for Big Tech, the real risk is not investing in AI. And if the trillion-dollar bet pays off, it could change the world as we know it.

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Key Insight

The massive levels of AI investment could force Big Tech to evolve into a business model similar to that of telecommunications companies, where constant investment in physical infrastructure is necessary to maintain business operations.

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