Microsoft Scales Back Neocloud Partners Amid AI Infrastructure Strain, Prioritizing Own Data Centers

Microsoft is significantly reducing the number of 'neocloud' partners it collaborates with, as it shifts focus to key suppliers and a stronger buildout of its own data center infrastructure, according to sources close to the matter. This strategic pivot highlights a growing strain in the artificial intelligence market, marked by increasing borrowing costs, substantial debt, and uncertainties about the future pace of AI infrastructure development.

Key Insights:

• Microsoft is consolidating its neocloud partnerships.
• The tech giant plans to enhance its proprietary infrastructure while maintaining relationships with essential suppliers.
• In recent years, Microsoft had engaged with numerous neocloud providers, including prominent names like CoreWeave and Nebius.

The software behemoth has forged alliances with several neoclouds over recent years, a list that includes CoreWeave, Nebius, Chronoscale, IREN, Lambda, and Nscale, alongside a partnership with Oracle, which is heavily investing in AI infrastructure.

Currently, Microsoft is in an evaluation phase, deciding which neocloud relationships to discontinue. Sources indicate that Microsoft intends to prioritize its expansive data center footprint. Reports from Bloomberg previously detailed these plans, and two individuals familiar with the situation confirmed that Microsoft opted not to renew its agreement with Oracle.

A Microsoft spokesperson affirmed the company's infrastructure strategy is built on "flexibility and choice." They stated, "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. We regularly review these investments against customer demand. That includes tracking delivery and adjusting plans as circumstances change."

The neocloud sector has recently experienced significant volatility on Wall Street, with rising interest rates fueling concerns over companies' heavy reliance on debt to rapidly expand capacity. Shares of CoreWeave, Nebius, and IREN have plummeted by roughly half over the past month, despite a recent rally.

An industry analysis recently identified 323 neocloud companies, with many experts predicting that a substantial number will not endure.

In its earnings report, IREN disclosed that while it delivered data center capacity to Microsoft in August, a networking equipment upgrade requested by Microsoft pushed the infrastructure's online date to January or February, instead of this year.

Microsoft's finance chief, Amy Hood, mentioned during the 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, impacting Azure cloud growth. Microsoft reported capital expenditures and finance leases totaling $45.2 billion in the latest quarter, with plans for accelerated capex spending in the latter half of the fiscal year.

Capital Markets Becoming More Selective

CoreWeave and Nebius are slated to release their quarterly results next week. IREN shares saw a 16% surge after the company announced its AI revenue more than doubled quarter-over-quarter to $200 million. IREN co-CEO Daniel Roberts noted a "disconnect between what we're seeing in public market and what we're seeing at the customer level."

However, Roberts acknowledged the market's current challenges: "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."

Microsoft has already reduced its engagement with UK-based neocloud Nscale, abandoning a planned site in England. Darren Hardman, Microsoft's CEO for the UK and Ireland, attributed this decision to Nscale's struggles to secure electricity access.

The Financial Times reported that Microsoft also chose not to renew a contract with Nscale in Texas. Nscale filed for an IPO in mid-September, expressing expectations that Microsoft would remain a "significant customer."

Microsoft's extensive reliance on neoclouds began after the 2022 launch of ChatGPT, which spurred immense demand for GPUs. This led to partnerships with companies like CoreWeave, a then-privately held startup with roots in cryptocurrency mining. Upon CoreWeave's public debut last year, 62% of its 2024 revenue was attributed to Microsoft.

Initially, OpenAI exclusively utilized Azure. However, its cloud suppliers have since expanded to include Amazon, Cerebras, CoreWeave, Google, and Oracle.

Microsoft's spokesperson reiterated that its approach to evaluating 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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