MSFT falls as investors remain focussed on AI spending despite layoffs

Microsoft's shares were falling on Monday even as the company announced its latest round of job cuts, as investors likely refused to look past the company's high AI investments.

A price target cut by Wolfe Research on Monday, citing higher memory prices, is likely to have also weighed on the stock, even though it maintained an Outperform rating on MSFT.

Shares of Microsoft MSFT fell about 1% on Monday afternoon after suffering a higher decline earlier in the day following the software giant's announcement that it would eliminate roughly 4,800 jobs, or about 2.1% of its global workforce, while restructuring its Xbox gaming business and continuing to ramp up spending on AI infrastructure.

The decline contrasted with the market's typical response to large-scale technology layoffs, which in recent years have often been viewed as signs of improving cost discipline and stronger profitability.

Microsoft's shares have fallen 18% so far this year, making the company a laggard among the Magnificent 7 stocks as it contends with investor pushback on the front of heavy AI capex spending while also being weighed down by their fears of AI disrupting software.

Layoffs accompany gaming overhaul

Microsoft said the restructuring would include significant changes to its gaming division, with plans to divest as many as five Xbox studios after years of heavy investment in the business.

The gaming overhaul will account for about 3,200 job cuts, including 1,600 layoffs announced on Monday.

The move comes as Microsoft increasingly prioritizes investments in artificial intelligence, which executives believe offer stronger long-term returns than its slower-growing gaming operations.

DA Davidson's Head of Technology Research Gil Luria said Microsoft's capital allocation reflects where management sees the greatest opportunity.

"AI drives more infrastructure software sales, then it drives more Office sales with Copilot. They have a much better place to invest right now. The gaming business doesn’t have much growth, so they might as well cut costs there in order to fund AI investment," he told CNBC.

Investors remain focused on AI spending

Unlike previous restructuring announcements across the technology sector, Microsoft's layoffs failed to reassure investors.

Amazon shares rose, albeit modestly, after the company announced plans to eliminate 16,000 roles earlier this year, while Meta's stock also gained following reports in March that it intended to cut more than 20% of its workforce.

Microsoft's shares, however, moved lower, suggesting investors remain more concerned about the company's rising AI investment bill than potential savings from workforce reductions.

AJ Bell investment director Danni Hewson said the market is still waiting for tangible evidence that Microsoft's enormous AI spending is translating into stronger financial performance.

"Markets are waiting to see solid financial evidence that all that capex is paying off and that the faith in AI as a growth supercharger has been warranted."

She added that investors may also have already priced in the restructuring after reports emerged last week that Microsoft was preparing another round of layoffs.

Parth Talsania, chief executive of Equisights Research, said the announcement was unlikely to provide a fresh catalyst for the stock.

"That (targeted cuts) makes the announcement read more like portfolio reallocation and operating discipline than a fresh catalyst for the stock."

"In the near term, the market is likely to reward Microsoft less for headcount reductions and more for evidence that AI monetization is scaling faster than AI-related costs," she said.

Rising AI costs weigh on forecasts

Adding to investor concerns, Wolfe Research reduced its price target on Microsoft to $525 from $570 while maintaining its Outperform rating.

Analyst Alex Zukin cited sharply higher memory prices following Micron Technology's latest earnings report, prompting the firm to raise its estimate for Microsoft's fiscal 2027 capital expenditure to $270 billion from $230 billion.

The higher investment outlook led Wolfe to project fiscal 2027 free cash flow of negative $17.4 billion, compared with its earlier estimate of positive $14.7 billion and well below the market consensus of roughly $31 billion.

The brokerage also lowered its fiscal 2027 gross margin forecast to 63.1% from 64%, compared with the consensus estimate of 66.6%, while trimming its earnings-per-share estimate by 1% to $19.02.

Despite the revisions, Wolfe remained optimistic about Microsoft's long-term AI strategy.

The firm said it "remains long-term bullish on MSFT's full-stack monetization approach to AI with Azure growth acceleration and rising Agent monetization potential."

It expects Azure revenue growth of 41% in fiscal 2027 and 40% in fiscal 2028, ahead of Wall Street expectations.

Zukin also pointed to Microsoft's disclosure of $11.5 billion in restricted investments linked to supplier agreements, which Wolfe believes "could reflect the company locking in a portion of component costs tied to memory," potentially reducing future pricing pressure.

Earnings expected to provide the next test

Luria argued that investors have become overly pessimistic about Microsoft's outlook by embracing two conflicting narratives simultaneously — that AI will weaken software demand while the company is overspending on AI infrastructure.

He rejected both views.

"The narrative on Microsoft has turned very negative, but that's an opportunity, because when they report in three weeks, they're going to report accelerating Azure growth and they're going to report capex growth that's at a lower rate than that."

Microsoft is scheduled to report fourth-quarter earnings on July 29.

According to Fiscal.ai data, Wall Street expects revenue to rise 15% year over year to $87.66 billion, while earnings per share are projected to increase to $4.24 from $3.65 a year earlier.

For investors, the results are likely to determine whether Microsoft's costly AI strategy is beginning to deliver the returns the market has been waiting for.