Microsoft Cuts The Power To AI

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3:10Better Offline. Now, I've talked about the pale horses of the AI apocalypse in the past, and these are the events that signify that the generative AI era is coming to an end. And the subject of this episode and its second part, Well, I believe represents the biggest paylist horses of the entire flock. So on February 21st, analyst T.D. Cohen revealed that Microsoft had cancelled leases, and I quote, totaling a couple hundred megawatts with at least two private data center operators across multiple US markets cancelled. The report also detailed how Microsoft pulled back on converting negotiated and signed statements of qualifications, SQQs, which it added was precursors to a data center lease.

3:49So, effectively the first step before you really agree to something, or the last step, I guess. Although the analyst, which is part of the TD Bank company, added it was unclear whether Microsoft might convert these SQQs in the future, these generally close to 100 % of the time according to them. Cancelling these was effectively rather unusual. Now, TD Cohen also added that Microsoft was reallocating a considerable portion of its projected international spend to the US, which suggests to Didi Cohen that there was a material slowdown in international leasing for Microsoft. But one crucial, teeny tiny part of the report was missed by just about everybody.

4:28I'm going to read directly from the report, and you'll probably be able to tell from the tone of my voice which the most pertinent part is. As we highlighted in our recent takeaways from PTC, the Pacific Telecommunications Council conference, We learned via our channel checks that Microsoft, one, walked away from multiple 100-plus megawatt deals in multiple markets that were in early to mid-stages of negotiations, two, let one gigawatt of LOIs on larger footprint sites expire, and three, walked away from at least five land parcels that it had under contract in multiple tier one markets. What TD Cohen is saying is not just that Microsoft cancelled some data centers, but that Microsoft also effectively cancelled over a gigawatt of data center operations on top of the previously reported multiple hundred plus megawatt deals.

5:14If we add in the land under contract, which is indeterminate based on what TD Cohen has said, and the deals that were in flight, the total capacity likely amounts to even more than a gigawatt. For some context, data center dynamics reported that Microsoft had five gigawatts of data center capacity in April 2024, saying that Microsoft had also planned to add one gigawatt of capacity by October 2024 and another one and a half gigawatts of capacity by the first half of 2025. Based on this reporting, one can estimate that Microsoft has somewhere between six and seven and a half gigawatts of capacity at this time.

5:46As a result, based on T.D. Cohen's analysis even, Microsoft has, through a combination of cancelled leases, pullbacks on statements of qualifications, cancellations of land parcels, and deliberate expiration of letters of intent, that's those LOIs, they've effectively abandoned data center expansion, equivalent to over 14 % of their current capacity. It's completely bloody insane. And this story just kind of sat there. It kind of knocked the market's confidence, but I don't know, I'm a lot more worried about this than I think people are. And really, I don't like telling people how to feel, but this kind of worries me.

6:20Okay, now I've thrown a lot of new terminology at you, but before we move on, let's explain some terms, because they're essential to understanding why this is all such a big deal. First of all, letter of intent, or LOI. In this context, it's a statement that an entity intends to lease or buy land or power from a data center. These can be binding or non-binding. A letter of intent is serious, though, and walking away from one is not something you do idly. It's not like not answering an email. Now, we'll go on to SQQs, statements of qualifications. These set the terms and conditions of a lease. While they do not themselves constitute a lease, they convert and to sign leases, as I mentioned, at an almost 100 % rate, according to TD Cohen, and are generally used as a signal to the landowner to start construction.

7:02Basically, they're the green light before the green light. As for tier one markets, these are markets for hyperscale growth, helped by favourable conditions like power, land, and cabling. From what I can tell, there's no fixed list of which cities are tier one and which aren't, but they include obvious candidates like London, Singapore, as well as Northern Virginia, which is the largest hub of data centers in the world. Finally, we're talking power, megawatt and gigawatt. This one is really important, but it's also really confusing. Data center capacity is measured not by the amount of computations the facility can handle, but rather by power capacity.

7:35And that makes sense, because power capacity is directly linked to the capabilities of the facility, with more power capacity allowing for more servers, or more power-hungry chips, of course. And because chips themselves are constantly getting faster and more power efficient, power makes a little more sense. If you measured in terms of computations per second, you'd likely have a number that fluctuates as hardware is upgraded and decommissioned. When you hear megawatt or gigawatt in this episode, assume that we're talking about capacity and not power generation, unless I say otherwise. Now with that out of the way, let's talk more about this report.

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12:08Data center build-outs take three to six years to complete, and the largest hyperscaler facilities can easily cost several billion dollars, meaning that these moves are extremely forward-looking. You don't just build a data center for the demand you have now, but for the demand you expect further down the line. This suggests that Microsoft believes its current infrastructure, and its likely scaled-back plans for expansion, will be sufficient for a movement that Satya Nadella once called a golden age for systems. He did that less than a year ago. To quote T.D. Cohen again, The magnitude of both potential data center capacity Microsoft walked away from and the decision to pull back on land acquisition, which supports core long-term capacity growth, in our view indicates the loss of a major demand signal that Microsoft was originally responding to, and that we believe the shift in their appetite for capacity is tied to OpenAI.

12:55To explain here, TD Cohen is effectively saying that Microsoft is responding to a major demand signal, and said major demand signal is saying you do not need more data centers. Said demand signal that Microsoft was responding to, in TD Cohen's words, is its appetite for capacity to provide servers to open AI. And it seems that said appetite is waning and Microsoft no longer wants to build out data centers for America's most swagged out AI guy. Now, I say that kind of as a joke, and I do think that he's more swagged out than Mark Zuckerberg. Mark Zuckerberg's trying too hard. However, Sam Altman is more damp than Mark Zuckerberg, so ultimately Zuckerberg wins.

13:30Now, I want to make it clear that Microsoft is effectively cutting its data center expansion by over a gigawatt of capacity, if not more. And it's impossible to reconcile these cuts with the expectation that generative AI will be this massive transformative technological phenomenon. I believe that the reason that Microsoft is coming back is that it does not have the appetite to provide further data center expansion for OpenAI, and it's having doubts about the future of generative AI as a whole. If Microsoft believed that there was a massive opportunity in supporting OpenAI's further growth, or that it had massive demand for generative AI services, there'd be no reason to cancel capacity, let alone cancel such a significant amount.

14:08These moves also suggest that Microsoft is walking away from building and training further large frontier models, like chat GPT's GPT 4.5 now, and from supporting doing so for others. Remember, Microsoft has significantly more insight into the current health and growth of generative AI than any other company. Remember, they have full access to all of OpenAI's tech, probably the future stuff too, not that there's much. They know all their research too. Microsoft knows something we don't. As OpenAI's largest backer and infrastructural partner, and the owners of the server architecture where they train their ultra-expensive models, not to mention the largest shareholder in OpenAI, Microsoft can see exactly what is or isn't coming down the pike, on top of having a view into both the sales of its own generative AI-powered software, such as Microsoft 365 Copilot, and sales of both model services and cloud compute for other models run on Microsoft Azure, which is their cloud platform.

15:00In plain English, Microsoft, which arguably has more data than anybody else about the health of the generative AI industry and its potential for growth, has decided that it needs to dramatically slow down its expansion. Now, to be clear, this expansion, I really am hammering this home a lot, but I need you to understand this, is absolutely necessary for generative AI to continue evolving and expanding, even if it only does so in ways that kind of do the same thing again and again. Now, before we move on, I want to make it clear that I'm not saying that Microsoft has stopped building data centers.

15:30I've said it a few times, but these projects take years, three to six years to complete, and are far, far in advance with their planning. And Microsoft does have a few big projects in the works. One planned 324-megawatt Microsoft data center in Atlanta is expected to cost$1.8 billion, and as far as I know, this deal is still in flight. However, and this was cited separately by TD Cohen, Microsoft has recently paused construction on parts of its$3.3 billion data center campus in Mount Pleasant, Wisconsin. While Microsoft had tried to reassure locals that the first phase of the project was on course to be complete on time, its justification for delaying the rest of it was, well, not brilliant.

16:08And it was to give Microsoft an opportunity to evaluate, and I quote, the project's scope and recent changes in technology and consider how this might impact the design of its facilities. Oh, buddy, that's not good. you don't want it no one evaluates the scope and then goes oh actually the scope is great i love it nor do they think about impacts and go oh let's do more no no no anyway the same register article i'm citing here adds that and i quote the review process may include the need to negotiate some building permits potentially placing another hurdle in the way of the project the register did add that microsoft said it expected to complete one hyperscaler data center in mount pleasant as originally planned, though its capacity wasn't available.

16:51Arguably, Microsoft would expand its data center infrastructure anyway. As more stuff moves to the cloud and our dependence grows on it, Microsoft and other providers need to build capacity. The organic growth is natural and sadly inevitable. However, Microsoft's plans for data center expansion were far, far in excess of that natural growth, and perhaps we're seeing a pullback from those stated extravagances into something perhaps a little more reasonable. Now, I've talked a lot about megawatts and gigawatts, and if you're not in the data center business, and you should be, the parties are in absolute love, this can all seem a bit abstract.

17:24So let's put it into context. Without context, it's hard to understand how big an 100 megawatt data center is. These are some of the biggest. According to the International Energy Agency, small data centers can consume anywhere between one and five megawatts. These are, for the most part, average-sized facilities. Perhaps not for cloud compute giants, but for other companies, it's kind of par for the course. 100 megawatts, by comparison, is huge. It's the equivalent of the annual energy consumption of between 350 ,000 and 400 ,000 electric cars. And I know some sort of pedant is going to say, it's not the same thing.

17:57Shut the fuck up. Go outside. Stop listening. Go outside. Go outside now. Go do something. Anyway, although there are others that will likely dwarf what we today consider to be a large facility, Meta is in the process of constructing, for example, a$10 billion data center campus in Louisiana with a proposed 2 gigawatt capacity. Still, whatever way you cut it, an 100 megawatt facility is big, and it's a big long-term investment. Cushman and Wakefield's 2024 global data center market comparison gives some chilling context into how significant Microsoft's pullback is. A gigawatt of data center capacity is roughly the entire operational IT load of Tokyo, which has a 1.028 gigawatt capacity, or London, 996 megawatts, or the Bay Area, which only has 842 megawatts.

18:42These are actually very large. It's just that Microsoft got rid of so much more. And again, the total figure of cancelled or abandoned capacity is likely far higher than a gigawatt. That number only accounts for the letters of intent that Microsoft allowed to expire. It doesn't include everything else, like the two data sentences it already killed, or the land parcels it abandoned, or the deals that were in early to mid-stages of negotiation. Imagine walking away from two Londons or two Tokyos of capacity and it not being a massive deal. This is a huge flippin' deal. Microsoft is not simply walking back some future plans.

19:14It's effectively cancelling what it loudly insisted was the future. If you think this sounds hyperbolic, consider this. London and Tokyo are respectively the biggest data center markets in Europe and Asia, according to the same Cushman and Wakefield report. Cancelling cities worth of capacity at a time when artificial intelligence is supposedly revolutionizing everything certainly suggests that artificial intelligence isn't really revolutionizing anything. Now, one other detail in TD Cohen's report really stood out to me. While there's pullback in Microsoft's data center leasing, it's also seen a commensurate rise in demand from Oracle related to the Stargate project, a relatively new partnership of up to$500 billion, stopped saying it's$500 billion to build massive new data centers for AI, specifically for one company, led by SoftBank and, of course, OpenAI, with investment from Oracle and MGX and a$100 billion investment fund backed by the United Arab Emirates.

20:08OpenAI has committed$18-19 billion to the Stargate project, money it doesn't have, meaning that part of the$25-40 billion that they're raising at the moment will be committed to funding these data centers, unless, as I'll get to later, OpenAI raises more in debt. Leading the round is SoftBank, which is also committing $18-19 billion, as well as creating a joint venture fund called SB OpenAI Japan to offer OpenAI services to the Japanese market, something that I thought was already happening, as well as spending$3 billion annually to use OpenAI's technology across its group businesses, according to the Wall Street Journal.

20:43In simpler terms, SoftBank is investing as much as, I think it's going to be like$30 billion in OpenAI than spending another$3 billion a year on software that only loses money and still hallucinates and shows no sign of getting meaningfully better or more reliable. Whether SoftBank actually sees value in OpenAI's tech or whether this purchase deal is a subsidy by the backdoor is open to debate. Given that$3 billion is equivalent to OpenAI's entire revenue from selling premium access to ChatGPT in 2024, which included some major deals with the likes of PricewaterhouseCoopers. I'm inclined to believe the latter.

21:16Even then, how is it feasible that SoftBank can continue paying? To get the deal done, Microsoft changed the terms of its exclusive relationship with OpenAI to allow it to work with Oracle to build out further data centers full of GPUs necessary to power OpenAI's big, shitty, unprofitable, and unsustainable models. The OpenAI Oracle Stargate situation was a direct result, according to reporting from the information of OpenAI becoming frustrated with Microsoft for not providing it with servers fast enough, including an allotment of 300 ,000 of NVIDIA's GBT200 chips by the end of 2025. For what it's worth, the Wall Street Journal reports that Microsoft was getting increasingly frustrated with OpenAI's constant demands for more compute.

21:56The relationship between the two entities had start to fray, with both sides feeling kind of aggrieved. This, combined with Microsoft's data center pullback, heavily suggests that Microsoft is no longer interested in being OpenAI's infrastructure paypick, long term at least. After all, it was, if it was, I mean, it'd fund and support OpenAI's expansion rather than doing the literal opposite. And you have to wonder if when that whole non-exclusive thing came along, whether Microsoft was kind of like, no, no, you couldn't possibly, like, the paper's already at the pen, they've already got a stamp of Sam Altman's signature, oh, don't sign it, it'd be so bad.

22:30No, I really don't, I don't think that Microsoft's too caught up about that.

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25:40And here's a question for you. If Generative AI had so much demand, why is Microsoft cancelling data center contracts? Why is Microsoft Oracle's largest customer as of the end of 2023, allowing SoftMank and OpenAI to work with Oracle to build the future rather than Microsoft. As mentioned previously, TD Cohen specifically noted in its report that Microsoft's shift in appetite for capacity was tied to OpenAI, which, as I've said already, heavily suggests that Microsoft is at best less invested in the future of the company. A statement confirmed by the Information, which adds that Microsoft have been trying to, and I quote, lessen its reliance on OpenAI technology as they increasingly compete in selling AI products.