Microsoft plans to use fewer neoclouds as AI buildout shows signs of strain

• Microsoft is looking to shrink the number of neoclouds it counts as partners, according to people familiar with the matter.
• The company will keep working with some key suppliers while it also builds out its own infrastructure, the sources said.
• Microsoft has signed deals with half a dozen neoclouds in recent years, including CoreWeave and Nebius.

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Microsoft is shrinking its roster of neocloud partners as it focuses on work with a few key suppliers and builds out its own data centers, according to people familiar with the matter.

The software giant's plans pose another potential challenge for a corner of the artificial intelligence market that's showing signs of strain due to rising borrowing costs, hefty debt loads and concerns about whether the buildout will slow down.

Microsoft has forged relationships in recent years with a number of neoclouds, including CoreWeave, Nebius,Chronoscale, IREN, Lambda and Nscale, as well as with Oracle, which is pouring money into building out AI infrastructure.

Microsoft is now in the evaluation stage and hasn't decided which neoclouds it will stop using, said two sources, who asked not to be named because the talks are confidential. One of the people said Microsoft wants to prioritize its own data center footprint. Bloomberg reported on the plans earlier. Two people said that Microsoft opted not to renew a deal with Oracle.

A Microsoft spokesperson said in an emailed statement that its infrastructure strategy is "built on flexibility and choice."

"We combine Microsoft-owned datacenters, leased facilities and strategic partnerships with third-party providers to deliver the capacity our customers need, where and when they need it," the spokesperson said. "We regularly review these investments against customer demand. That includes tracking delivery and adjusting plans as circumstances change."

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The neoclouds have been a turbulent trade on Wall Street in recent weeks as rising interest rates added to fears that many companies have become overly reliant on debt in rushing to build capacity. Shares of CoreWeave, Nebius and IREN are all down by roughly half over the past month even after rallying on Friday.

A recent industry review counted 323 neoclouds, and experts have predicted that many of them won't survive.

In its earnings report on Thursday, IREN said it handed over data center capacity to Microsoft in August, but Microsoft requested a networking equipment upgrade that will result in the infrastructure coming online in January or February instead of this year.

Microsoft finance chief Amy Hood said on the software company's fiscal first-quarter earnings call in October that some cloud contracts involving graphics processing units were delayed until the first half of 2027, affecting Azure cloud growth. Microsoft reported $45.2 billion worth of capital expenditures and finance leases during the latest quarter, and said capex spending will accelerate in the second half of the fiscal year.

Capital markets 'more selective'

CoreWeave and Nebius are both scheduled to report quarterly results next week. IREN shares popped 16% on Friday after the company said AI revenue more than doubled from the prior quarter to $200 million. IREN co-CEO Daniel Roberts told CNBC that there's a "disconnect between what we're seeing in public market and what we're seeing at the customer level."

However, he acknowledged the challenge that market conditions present.

"Capital markets have become more selective in the last few weeks, and the questions have undoubtedly moved from how big the contract is to whether it can be delivered, financed, and run at a profit," Roberts said on the earnings call.

Microsoft has already slashed its work with U.K.-based neocloud Nscale, walking away from a site that it had intended to use in England. Darren Hardman, Microsoft's CEO for the U.K and Ireland, told CNBC in October that the decision had to do with Nscale's ability to get access to electricity.

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The Financial Times reported this week that Microsoft decided against renewing a contract with Nscale in Texas. Nscale filed to go public in mid-September but hasn't updated its prospectus since then. The company said in its IPO filing that it expects Microsoft to be a "significant customer in future periods."

Microsoft's big turn to neoclouds came after the launch of ChatGPT in 2022, which led to a surge in demand for GPUs. In looking elsewhere, Microsoft signed up CoreWeave, which was a privately held startup at the time with roots in cryptocurrency mining. When CoreWeave went public last year, it said 62% of its 2024 revenue came from Microsoft.

At the time of ChatGPT's release, OpenAI only used Azure. Now the company's cloud suppliers also include Amazon, Cerebras, CoreWeave, Google and Oracle.

Microsoft's spokesperson said that its approach to reviewing neocloud investments is "a normal and responsible way to manage large, complex infrastructure projects," and that "the pace of our new agreements reflects what we need today."

—CNBC's Kif Leswing contributed to this report.

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