AI projects moving to more broad implementations lead S&P Global Ratings to expect more enterprise IT spending in 2025.

Enhanced deal scrutiny and tight budgets amid ongoing macroeconomic uncertainties characterize cautious enterprise IT spending. We expect IT spending to increase about 8% in 2024 from 4% in 2023, but less than we would have expected given supportive GDP growth. We believe geopolitical tensions and still-high interest rates are weighing on IT budgets, along with uncertainty about the outcome of the U.S. election, although this should be resolved shortly.

We expect IT spending will improve in 2025 as AI projects move from the proof-of-concept phase and companies execute on data center infrastructure and edge device refreshes. We believe net new budget dollars will contribute to AI investments, making room for general purpose IT spending to rebound on product refreshes in the PC, server, storage, and networking segments.

Awaiting The 2025 PC Refresh Cycle

The PC market is showing early signs of stabilization but remains subdued. International Data Corp. (IDC) reported that third-quarter shipments declined 2.4% year over year because inventory replenishment led to a surge the prior quarter. However, demand has begun to return, particularly in the entry-level segment, driven by recovering economies and back-to-school purchases. We expect PC shipment growth of 1% for 2024 with more robust growth anticipated in 2025, supported by Microsoft Corp.'s Windows 11 upgrade cycle and Windows 10 support ending in October 2025, the refresh of the COVID-19-era PC cohort as devices turn 4 and 5 years old, and increasing enterprise adoption of AI-enabled PCs. While AI PCs are generating significant industry hype, their impact on demand has been limited so far but should increase market share.

Server, Storage, And Networking Deliver Mixed Performance

The server market shows a clear split between AI and general purpose servers. AI server demand remains robust, particularly from Tier 2 cloud service providers, with total server sales projected to triple to $332 billion by 2028 from $134 billion in 2023, according to Gartner. General purpose server demand is also showing signs of improvement, with three consecutive quarters of growth from Dell Inc. Storage has benefited from healthy pull-through from new high-performance compute and AI projects and modernization of backup and recovery systems.

The networking segment remains challenged, with enterprise budgets constrained despite having completed an inventory correction. We don't expect a more meaningful recovery in networking spending until 2025 as customers prioritize other areas of data center infrastructure. Inventory digestion issues are largely concluded, except for some remaining inventory in the service provider segment.

Software Companies Still Figuring Out AI Monetization

Firms are pursuing various strategies to monetize AI capabilities, with approaches varying by vendor. Some vendors are embedding AI features into existing products to drive demand, while others are implementing separate pricing for AI capabilities. Microsoft's approach with its 365 Copilot represents a premium pricing model, while other vendors are including AI features within existing pricing to create differentiation on performance and capability. Companies are increasingly focusing on demonstrating clear return on investment for AI implementations, moving beyond proof-of-concept stages. Many early experiments have not driven sufficient value, leading to more careful consideration of AI investments.

Contact center operations, digital advertising, and coding have emerged as the most immediately applicable areas for AI implementation. Many software companies are forming strategic partnerships to enhance their AI capabilities, such as Microsoft's partnership with OpenAI, ServiceNow Inc.'s collaboration with NVIDIA Corp., and SAP SE's partnerships with large language model providers such as Mistral AI.

Smartphone Market Steadily Recovering With AI Features Incoming

The sector marked its fifth consecutive quarter of shipment growth at 4.1%, according to IDC. A turnaround in China has aided the market with a 3.2% expansion, with domestic phone makers leading the way. Huawei has staged an impressive comeback after years of sanctions limited its access to advanced chips. We expect global units to increase 4% in 2024.

The market is increasingly focused on AI capabilities, with major manufacturers such as Apple Inc. and Samsung Electronics Co. Ltd. incorporating AI features into their flagship devices, betting they will drive an upgrade cycle. Apple's recent launch of Apple Intelligence and Samsung's Galaxy AI features represent significant steps toward AI-enabled smartphones, though the impact on consumer demand will be gradual as users become comfortable with use cases and as the AI ecosystem develops. Apple just released features including writing tools, more natural and conversational Siri, and enhanced photos. ChatGPT integration and non-U.S. English support are coming in December, with more features and languages coming thereafter.

AI's Torrid Expansion Drives Record Investment, Nuclear Deals

The latest earnings reports from major cloud providers reveal an industry in robust growth, driven by AI adoption and improving core cloud demand. The combined revenue growth of Amazon Web Services (AWS), Azure, and Google Cloud Platform accelerated for the fourth consecutive quarter to 22% year over year, demonstrating the sector's strong momentum.

Demand for AI compute capacity continues outstripping supply. Microsoft CFO Amy Hood noted that "demand continues to be higher than our available capacity," while Amazon.com Inc. reported similar constraints for AWS. Microsoft disclosed that AI services will exceed $10 billion in annualized revenue this quarter, with AI-related services contributing 12 percentage points to Azure's 33% growth the prior quarter. AWS reported its AI business is expanding at a triple-digit rate, with billions of dollars in annual revenue, while Google Cloud's revenue increased 35% year over year, partly driven by AI workloads.

Beyond AI, general purpose cloud services are showing signs of renewed strength. Enterprise customers are increasingly recognizing that cloud migration is important for accessing advanced AI capabilities. Cloud providers report that optimization efforts by customers are diminishing, while new workload migrations are accelerating. Multicloud approaches are becoming more common, benefiting large-scale providers outside of the top two, Google LLC and Oracle Corp.

The unprecedented demand for AI computing is driving massive capital investment in data center infrastructure. Microsoft, Alphabet Inc., and Meta Platforms Inc. spent $36 billion on capital expenditure (capex) in the latest quarter, up 48% from last year. We estimate they will increase about 50% in 2024, followed by more than 20% growth in 2025. This would be a $30 billion expansion in 2025 compared to almost $50 billion this year amid a significant build-out of data center structures to be filled with equipment later.

A critical challenge is securing reliable power supply for energy-intensive AI data centers.   Major providers are making significant commitments to nuclear power, despite its high costs and long development timelines. Google recently announced the first U.S. deal supporting commercial construction of small modular reactors, aiming to add 500 megawatts of capacity starting at the end of the decade. Amazon followed with similar agreements in Virginia and Washington while also investing in nuclear technology company X-energy. Microsoft partnered with Constellation Energy Group Inc. in a $1.6 billion deal to restart a reactor at Three Mile Island by early 2028.

These nuclear investments align with the providers' sustainability goals while ensuring consistent power supply--a crucial advantage over intermittent renewable sources such as wind and solar. However, the projects face significant challenges including regulatory approvals, construction delays, and community acceptance. AWS CEO Matt Garman acknowledged that nuclear power "won't solve anything in the 2020s," suggesting providers will rely heavily on existing power infrastructure, including fossil fuels, in the near term.

The scale of infrastructure investment reflects cloud providers' confidence in long-term AI demand.   Microsoft emphasized that approximately half of its cloud and AI spending is for long-lived assets with more than 15-year monetization horizons. Meta signaled significant increases in AI-related capital spending for 2025, while Microsoft, Google, and Amazon all indicated sustained high investment ahead. This positions the industry for continued strong growth as enterprise AI adoption accelerates, though managing the massive capital requirements and ensuring adequate power supply remain key challenges.

AI Semiconductor Demand Strong; General Purpose Markets Mixed

The semiconductor industry presented a complex picture in the third quarter, with divergent signals from key players. Early in the earnings season, ASML Holding N.V.'s report of order pushouts suggested potential headwinds in advanced chip production. We think Taiwan Semiconductor Manufacturing Co. Ltd.'s (TSMC) strong results and optimistic forecast will prove to be the more reliable indicator given its broader market exposure. ASML's weaker outlook appears attributable to specific challenges faced by customers such as Samsung and Intel Corp. in their competitive positioning in the foundry segment, along with TSMC's concerns about the high costs associated with ASML's latest extreme ultraviolet lithography tools.

Demand for data center chips remains robust, driven by continued investments in AI and cloud infrastructure. TSMC expects AI-related revenue to more than triple in 2024 and a represent mid-teens percentage of overall revenue. Advanced Micro Devices Inc. (AMD) raised its AI GPU revenue forecast for 2024 to over $5 billion, reporting strong adoption of Epyc CPUs by major customers such as Meta, which has deployed over 1.5 million units. General purpose server CPU demand is showing signs of improvement, with both Intel and AMD noting recovery in their respective server businesses.

The industrial segment continues to face headwinds, with most manufacturers reporting persistent weakness. While many subsectors appear to have reached a cyclical bottom, recovery timing remains uncertain as customers continue to reduce inventory. Texas Instruments Inc. noted that industrial markets have stabilized but are still hovering near cyclical lows.

The automotive semiconductor market is in a notable slowdown, though the expected peak-to-trough decline should be less severe than in the industrial sector. Secular growth drivers support this relative resilience, including increasing electronic content per vehicle, driven by electric vehicle adoption and advanced driver assistance systems. However, manufacturers are noting shifts in the market, with STMicroelectronics N.V. reporting a move away from battery electric vehicles toward hybrids in Western markets, while China's electric vehicle market maintains momentum.

PC and smartphone markets are progressing through inventory corrections, with manufacturers reporting gradual improvement in channel inventory. TSMC noted that demand for non-AI applications is beginning to stabilize and expects it to improve.

We expect pricing pressure to intensify for mature semiconductor nodes due to increasing competition from Chinese manufacturers and subdued demand across consumer electronics, PC, smartphone, automotive, and industrial segments. Automotive semiconductor pricing, which has remained remarkably stable through 2024 helped by long-term agreements, may face normalization pressures as the market works through current challenges.

Incumbent Memory Leaders Rush Upmarket Amid Chinese Competition

Memory semiconductor manufacturers indicate a stark divergence between AI-driven demand and general purpose market segments. Robust demand and pricing power remain in high-bandwidth memory (HBM) DRAM and enterprise solid-state drives (SSD), driven by the AI boom. SK Hynix Inc. reported HBM revenue growth of more than 70% quarter over quarter and more than 330% year over year, expecting it to represent over 40% of DRAM revenue in the fourth quarter. The company has already sold out its 2025 HBM capacity. Similarly, enterprise SSD demand remains strong, with Western Digital Corp. reporting a 76% quarter-over-quarter increase.

However, legacy memory products face mounting pressure from Chinese competitors, particularly in legacy DRAM. While Chinese manufacturers still lag in technology, they are employing aggressive pricing strategies to gain market share, particularly in China's domestic market. In response, established players are strategically converting legacy capacity to premium products. This transition helps reduce supply in legacy segments while supporting higher-margin products.

The PC and smartphone segments continue to face headwinds from inventory corrections. Samsung reported weak mobile demand for both DRAM and NAND, expecting a mid-single-digit percent decline in DRAM bits for the fourth quarter due to Chinese mobile clients' inventory adjustments.

Capital investment remains measured, reflecting a cautious approach after recent market corrections. Micron Technology Inc. projects meaningfully higher fiscal 2025 capex at the mid-30% area of revenue, primarily directed toward HBM production and new factory construction. Samsung maintains flat memory capex, focusing on research and development facilities and HBM capacity, while SK Hynix's increased spending primarily targets infrastructure rather than bit growth. This disciplined approach to capacity expansion, particularly in legacy segments, suggests memory makers are prioritizing profitability over market share as they navigate the ongoing market recovery.

Balanced Rating Actions Mostly Negative In 'B' Category Or Lower

In the second half to date, U.S. technology investment-grade issuers have a positive bias and speculative-grade issuers a negative one. Most negative actions were for companies in the 'B' category or lower due to high interest expense and idiosyncratic business challenges.

Since the start of the third quarter, we have downgraded seven entities and upgraded five. Among investment-grade issuers, we upgraded ServiceNow to 'A' as we took a more constructive view of its business. It is now in the same business risk category as Adobe Inc. and Salesforce.com Inc. We also upgraded Uber Technologies Inc. to 'BBB-' because we came to view its business as supportive of an investment-grade rating with strong bookings growth above 20% and improving profitability and free cash flow. The company's gross leverage target of 2x and goal of maintaining an investment-grade credit profile also support the action. The positive outlook indicates the possibility of further upside in 2025. We downgraded Intel to 'BBB+' following weak performance as it faces challenges in executing its turnaround. The outlook is negative.

Among speculative-grade issuers, we downgraded six and upgraded three. We took three rating actions on Magenta Buyer LLC: a downgrade to 'CCC', a downgrade to 'SD' (selective default), and then an upgrade to 'CCC+'. The company completed a distressed exchange because of pressure from higher interest rates and poor product-market fit in the highly competitive but quickly expanding cyber security market.

Three of the four remaining downgrades carry negative outlooks, indicating the potential for further rating actions, including for Xerox Holdings Corp. We downgraded both Redstone Buyer LLC (doing business as RSA) and VeriFone Systems Inc. to 'CCC+', indicating our view that these companies face increased risk of a distressed transaction due to the questionable sustainability of their capital structures. We upgraded MicroStrategy Inc. to 'B-' on an incrementally more constructive view of the bitcoin ecosystem, which nevertheless remains highly speculative and volatile, in our view.

Among outlooks that we revised, six were positive and three negative.   We revised our outlook on Analog Devices Inc. to positive, reflecting the trend within the semiconductor industry of broadening end markets with high long-term growth prospects leading to larger scale and lower earnings volatility, despite the recent weakness in the industrial and automotive end markets. Marvell Technology Inc. is among the companies benefiting from AI demand due to its high-speed connectivity and custom silicon products. Seagate Technology Holdings PLC is enjoying a sharp rebound from a long and deep inventory correction because of its hyperscale data center customers with strong growth due to workload migrations from on-premises to the public cloud.

We took two positive actions related to equity raises. We upgraded Allegro MicroSystems Inc. to 'BB-' as it raised equity to repurchase shares from Sanken Electric Co. Ltd., lowering its ownership stake such that we no longer view Sanken as having a material negative influence on Allegro's long-term financial policy. We also placed Ingram Micro Inc. on CreditWatch with positive implications after it filed to go public, intending to use proceeds to repay debt.

Finally, we assigned ratings to two new issuers: Clover Holdings 2 LLC (doing business as Cohesity) a 'B' rating as it will acquire Veritas Holdings Ltd.'s data protection business and Icon Parent I Inc. a 'B-' rating as KKR created it to take Instructure Holdings Inc. private.