Melius Downgrades Microsoft (MSFT) to Hold, Flags AI Capex and Cash Flow Risks

Microsoft Corporation (NASDAQ:MSFT) is one of the 10 AI Stocks Analysts Are Watching. On February 9, Melius analyst Ben Reitzes downgraded the stock from Buy to Hold with a $430 price target.

Investors have been growing increasingly wary about the potential disruption software stocks face from AI. Particularly for MSFT, analyst sees structural AI risks and limited near-term upside at current valuation.

Melius highlighted that Microsoft’s 365 business is facing threats from AI, implying a need to increase its capital expenditure substantially to keep up with Amazon and Google. However, it noted that cash flow may take another hit.

If Microsoft doesn’t increase its spending now, analysts at Melius believe that it may either be an execution issue or a need to manage earnings. Both cases, however, aren’t good.

The tech giant’s decreased free cash flow will make it look much less attractive when compared to its competitors.

“Given the free cash flow shortage, one could argue equity values for these stocks are nothing more than ‘vibes’ on AI prospects that hinge on what stronger free cash flow may look like in the 2030’s,” he wrote. “We may be only in the early stages of this investor aversion to ‘vibes’ that puts the premium back on free cash flow. That’s why we’ve kept buys on AI semis and select hardware names like Apple that all directly benefit from other people’s spending — and generate a ton of cash.”

Reitzes also criticized how slow the company is moving when it comes to its AI-powered assistant, Copilot.

“Anthropic developed Cowork in 10 days and most think it works better with Excel and other plug-ins vs. Copilot,” he said. “Due to things like Cowork from Anthropic, Microsoft’s powerful 365 suite could see challenges and may need to give Copilot away just to stay relevant — hurting growth and margins in its most profitable Productivity segment. This reality will consume internal capacity of Azure, limiting beats there too.”

Melius also highlighted valuation concerns for MSFT, stating that it appears expensive based on their revised free cash flow estimates.

Microsoft Corporation (NASDAQ:MSFT) provides AI-powered cloud, productivity, and business solutions, focusing on efficiency, security, and AI advancements.

While we acknowledge the potential of MSFT as an investment, we believe certain AI stocks offer greater upside potential and carry less downside risk. If you’re looking for an extremely undervalued AI stock that also stands to benefit significantly from Trump-era tariffs and the onshoring trend, see our free report on the best short-term AI stock.

READ NEXT: 30 Stocks That Should Double in 3 Years and 11 Hidden AI Stocks to Buy Right Now.

Disclosure: None. This article is originally published at Insider Monkey.