- Big tech firms are seeing early AI-driven cloud revenue growth, but concerns around declining cloud-margins and negative free cash flow persist
- AI is less successful in customer-facing tasks but more adept at cutting costs in back-office tasks benefitting banks; Advertising, gaming, and e-commerce are key sectors to benefit
- We prefer players with AI adoption benefits in their core businesses, exposed to leading LLMs and with a lower reliance on expensive Nvidia chips
Related insights
Rising hyperscalers capex signals success of AI pilots. After years of heavy AI capex, US hyperscalers are delivering robust growth in their cloud revenue, either meeting or exceeding street expectations. However, cloud margins faced pressure due to rising depreciation and amortisation costs, while cash flow concerns deepened as 3Q25 guidance points to higher AI capex for 2025 and 2026. We think the market is overly focused on lower cloud margins and overlooking the benefits of AI adoption in their core businesses, such as advertising, gaming, and e-commerce. For example, Meta, Alibaba, and Tencent benefit from higher click-through rates in their advertising business, while Amazon benefits from more personalised recommendations plus a reduction in fulfilment costs supported by AI-led Robotics.
While AI is less successful in customer-facing tasks as they involve unstructured interactions and human emotions, it is more adept at repetitive, data-intensive back-office tasks. Banks are also likely to benefit from lower costs for compliance and documentation. We expect the free cash flow of hyperscalers to only stabilise in 2027, mainly driven by higher AI revenue. With AI deployment (Inferencing) likely to overtake AI training by the end of 2025, revenue could see a big jump in 2027.
Cloud revenue accelerates, margin trends mixed. Latest results showed that overall operating margins rose for some players despite a decline in cloud margins. Annual cloud revenue growth accelerated across major hyperscalers. Amazon’s cloud revenue accelerated from 17.5% in Jun 2025 to 20.2% in Sep 2025, Microsoft from 25.6% to 28.2%, and Alphabet from 31.7% to 33.5%. Alibaba’s cloud revenue growth is also expected to accelerate from 25.8% in June quarter to 28.1% in September quarter. Conversely, cloud operating margins softened across most peers, except for Alphabet (17.1% in Sep 2024 to 23.7% in Sep 2025) and Alibaba (guided stable at 8.8%).
Overall operating margin trend was mixed. Meta’s operating margin dropped from 42.7% in Sep 2024 to 40.1% in Sep 2025, while Alibaba’s EBITA margin is expected to drop from 17.2% to 5.0% (during the same period), due to intensified quick commerce competition. On the other hand, Microsoft (46.6% to 48.9%) Alphabet (32.3% to 33.9%), Amazon (11.0% to 12.1%) delivered expansion. We also expect Tencent’s operating margin to expand from 36.6% to 38.1% during the same period.
AI themes at the forefront. According to Menlo Ventures, Anthropic has emerged as the leading enterprise Large Language Model (LLM) provider with 32% market share in mid-2025. OpenAI’s share has dropped to 25%, from 50% in 2023, while Alphabet’s Gemini has reached 20% market share after being a late starter. Alphabet is leveraging its decade-old investment in its custom AI chips, Tensor Processing Units (TPUs) to efficiently handle AI Training & inference workloads at a fraction of cost than Nvidia chips. Anthropic is deploying Amazon’s Trainium Chips for training its models and is readily accessible to AWS customers via Amazon Bedrock. Alibaba also offers its own innovations: its popular Qwen models in China, and its own Parallel Processing Unit (PPU) for AI inferencing in the long term.
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