Tech Giants' Capital Spending Highlight | A Race Between Free Cash Flow (FCF) and Capex

Investors have been paying close attention to the capital expenditure dynamics of major technology companies in recent years. The rise of AI makes the technology industry unwilling to miss the opportunity unseen in decades. Arete Research predicts that these companies will allocate approximately $480 billion toward capital expenditures over the coming two years. However, the cash inflows and additional profits brought by AI still require many years to be realized, forcing companies to endure the erosion of free cash flow during this economic cycle due to their investments.

▶ Comparison of Capex levels across different time periods in history

Statistics show the peak growth rate of AI capital expenditure by major four tech giants (Microsoft, Meta, Alphabet, and Amazon) in this round (2024E-40.9%) does not exceed the peaks during the three historical rounds of cloud computing capital expenditure (2010-67.6%, 2013-55%, 2018-60.3%).

Correspondingly, free cash flow (FCF) has been eroded in those years, although historically, only in 2013 and 2022 did the two-year compound growth rate of FCF turn negative.

The current Capex growth rate is only higher than the peak during the 2020 pandemic cloud computing investment (34%), and the growth rate of free cash flow is also significantly better than previous investment peaks. Therefore, this round of AI investment remains relatively restrained.

▶ Comparison of Capex levels among different companies

From the perspective of the Capex/Sales Revenue ratio, except for Microsoft, which is at the peak of Capex level, Amazon, Google, and Meta are all lower than the historical investment peak proportion. Considering that Microsoft is gradually transitioning from a pure software company to a cloud computing company, the historical ratio trend is also increasing.

▶ Sensitivity analysis of Capex growth rate and Free Cash Flow

UBS conducted a sensitivity analysis for capital expenditure growth rates in 2025, suggesting that if major tech companies want to maintain a positive FCF growth rate in 2025, the Capex growth rates for Microsoft, Amazon, Google, and Meta should not exceed 36%, 41%, 47%, and 35%, respectively. Furthermore, if they aim for positive FCF growth in 2026, the Capex ceiling would need to be further reduced.

Since companies do not want their FCF growth rate to be merely zero, the actual Capex figures are likely to be lower than the forecasted values. UBS actually believes that it is more probable for these four companies to experience Capex growth rates between 15%-25% next year, which would enable double-digit FCF growth.

▶ What does it mean?

1. The degree of cash flow erosion due to capital expenditure in this economic cycle is not high compared to previous periods. Therefore, market concerns about the difficulty of monetizing AI revenue for major tech companies might be somewhat exaggerated, as other core businesses could significantly offset these losses. Especially for Amazon, its FCF growth expectations are higher than its peers. Therefore, Amazon has greater potential for Capex growth.

It's not easy to determine how much of the growth in cloud business of major tech companies can be directly attributed to AI. Management teams from The Four have made optimistic statements about AI's potential to stimulate new growth. During the earnings call, it was highlighted that AI could enhance ROI for advertisers and boost infrastructure revenue, as evidenced by strong performances from Azure, GCP, and AWS. Additionally, AI is expected to drive innovation in customer-facing applications.

Microsoft CEO Satya Nadella remarked that the "near-term AI demand exceeds our available capacity," indicating that the current GPU supply is insufficient to satisfy customer demand.

2. To maintain profitability and cash flow growth, major companies may have to progressively reduce the growth rate of Capex in 2025 and 2026. This could impact upstream data center chip providers, such as Nvidia and AMD, as well as their associated manufacturers. Since growth stocks often use the PEG (price/earnings-to-growth) valuation method, a slowdown in the capex growth rate of tech giants could lead to a corresponding decline in the PEG valuations of chip manufacturers.

Therefore, for Jensen Huang, the key to continuing his chip legend lies in whether he can continue product iterations, increase product prices due to improved performance, and exert pressure on upstream suppliers to maintain high gross margin levels.

Risk Disclosure: The forecasts above are provided by third-party research institutions; corporate cash flows could be overestimated or underestimated due to the impact of macroeconomic factors.