After losing to Apple for 14 consecutive quarters, can Microsoft's market value return to the first place in the US stock? Yes, by AI!

Focus

1) Microsoft is introducing generative AI into almost every aspect of its business to change the way the future of work is done, and then surpass Apple to reclaim the "most capable" throne.

Copilots can transform the jobs of 1.2 billion Microsoft 365 users and 1.4 billion Windows users. This will allow Microsoft to attract new customers and charge them more.

3. Microsoft's business relies on three divisions to achieve growth: cloud computing business Azure (approaching the scale of AWS, Microsoft 365 (accounting for 1/4 of Microsoft's total revenue), and network security business.

4. In terms of generative artificial intelligence, Microsoft has two major advantages, namely a wider range of software sold and a first-mover advantage, deploying artificial intelligence faster than competitors.

5. All generative AI tools face three major challenges: infringement legal issues, large model errors, and data governance. Microsoft may even be embroiled in antitrust lawsuits for abusing its market dominance.

Since being surpassed by Apple in the first quarter of 2020, Microsoft has been in the position of the "second" in the US stock market value for 14 consecutive quarters. Microsoft's market capitalization, can it catch up with Apple?

For years, Microsoft has tried to convince office workers to use its office software to write reports, fill out spreadsheets and make slides. However, things seem to have changed now, and the soft-armored giant wants to ghostwrite reports directly for them, autofill forms, and automatically generate slide presentations.

At its tree-lined Redmond headquarters on the outskirts of Seattle, Microsoft, showcased its latest magic. A blank Word document has a small gray rectangle at the top, and with just a few simple instructions, an artificial intelligence (AI)-powered chatbot (Microsoft calls it Copilot) can find a huge file in a computer folder and summarize its contents. After that, it edits own work and concisely answers questions about the material. It can also perform many other functions: dig through emails on specific topics, make to-do lists based on meetings, and even make great PowerPoint presentations for journalists.

Needless to say, this is a vision of the future of work, and the incredible capabilities of generative AI seem set to transform many desk jobs. It's also a prediction for the future of Microsoft, once the world's most valuable tech company and hoping to reclaim that title by selling the technology that drives transformation. By investing in OpenAI, Microsoft is able to infuse cutting-edge AI technology into its products. OpenAI is the company behind the development of the popular AI chatbot ChatGPT.

Big bet Copilot made a lot of money

This doesn't just mean that Microsoft will be adding Copilot to the office suite (previously called "Office" but recently renamed "Microsoft 365") that will launch in November. This week, Microsoft will launch a Copilot for Windows operating system that will be able to change your computer's settings and generate images and snippets. Copilot, which sells software and human resources services, is already available, and one of them, Copilot, for its security software, is also in development. In February, Microsoft added chatGPT-like functionality to its search engine Bing, which is actually another Copilot. Microsoft is bringing generative AI to almost every aspect of its business.

This is probably the biggest bet any company has made on AI, and of course the potential rewards are huge. Copilots can transform the jobs of 1.2 billion Microsoft 365 users and 1.4 billion Windows users. This will allow Microsoft to attract new customers and charge them more. That, in turn, could drive business to Microsoft's high-margin cloud business, Azure, potentially helping it overtake Amazon rival AWS to become the world's largest cloud company. Copilots could even help Microsoft's market cap surpass its current $2.3 trillion, potentially closing the gap with Apple, which is currently the world's most valuable company.

Mark Moerdler, a broker at Bernstein, a well-known investment bank in the United States, believes that in fact, artificial intelligence provides a tantalizing opportunity for Microsoft to do things that it has not been able to do so far and integrate everything it provides. If Microsoft's video conferencing service Teams, equipped with Copilot, can sort employees' emails in Outlook and extract information from their Word documents and PowerPoint, it could appeal more to IT managers than rival Zoom. All of these amazing features can be enabled through Azure, furthering Microsoft's business.

Still, Microsoft is actually making a big bet. The company's capital spending is expected to jump nearly two-fifths next year to about $40 billion, which is almost 16 percent of Microsoft's total revenue and higher than any tech giant except Facebook's parent company Meta. Most of the money will be used to purchase new AI chips and build high-performance networks to take advantage of the more than 120 additional data centers it plans to come online. Whether such an investment will pay off remains an open question.

Despite Microsoft's promises, Copilots still has a lot of problems. In Redmond's presentation, AI-generated slides described the reporter as "the CEO of ABC," but this was by no means the case. At the same time, competitors, especially Google's parent company Alphabet, are coveting the same market. As the battle for the future of working intensifies, Microsoft's position is enviable, but not invulnerable.

Putting yourself in this position is a long-term effort. Microsoft entered its heyday in the 90s: Windows' dominance in the operating system space, combined with a brutal business mindset, made Microsoft stronger, but was met with widespread criticism. A period of stagnation ensued, as it could only survive on Windows revenue.

After Satya Nadella took office in 2014, he overhauled the company. Windows is no longer Microsoft's main business. Instead, the company restructured around Azure, moving blockbuster projects like Office to the cloud. This involves massive data center builds, with Microsoft's capital expenditure as a percentage of revenue rising from 6 percent in 2014 to 11 percent five years later. Crucially, the company abandoned the closed garden approach, allowing Microsoft's software to run on other operating systems, such as Google, Apple and Linux (an open-source competitor to Windows).

At the same time, Microsoft is also investing in artificial intelligence. The company first announced its partnership with OpenAI in 2016. Since then, Microsoft has invested $13 billion in the latter and has a 49 percent stake. The agreement not only allows Microsoft to use OpenAI's technology, but also stipulates that OpenAI's models and tools run on Azure, effectively making OpenAI's customers Microsoft's indirect customers as well. It's not just OpenAI. Since Nadella took office, Microsoft has acquired 15 AI-related companies, including a $20 billion acquisition of Nuance, a healthcare company with cutting-edge speech-to-text technology, in 2022.

Today, Microsoft's business relies on three divisions for growth. The first is Azure. For the past 5 years, Azure has been approaching the scale of AWS. But cloud spending is slowing as IT managers tighten their pocketbooks. Still, in the most recent quarter, Microsoft's cloud business grew 27% year-over-year. Microsoft did not disclose specific sales for Azure, but analysts believe it accounts for about a quarter of the company's revenue, which reached $212 billion last year. The gross margin of Microsoft's cloud business is also kept secret, but Bernstein believes that its gross profit margin is as high as about 60%.

This is followed by Microsoft 365, which also accounts for about a quarter of Microsoft's total revenue. Recently, thanks to the growth of small businesses, especially in service industries such as restaurants, this figure has been growing at a rate of about 10% per year.

The third source of growth is cybersecurity. Microsoft executives said on the earnings call that the business has revenue of about $20 billion (about one-tenth of total revenue). That's more than the combined revenue of the five largest companies that only provide cybersecurity services. More importantly, the revenue of the business is growing at an annual rate of about 30%.

Separately, given that the UK's antitrust regulator has said that they will approve Microsoft's $69 billion acquisition of game maker Activision Blizzard, Microsoft's video game division, which brings in $15 billion in annual revenue, will also grow significantly.

Microsoft AI has two major advantages

Using Azure as the underlying infrastructure for the rest of Microsoft's business helps spread costs, simplify operations, and improve profits. Since 2014, Microsoft's operating margin has risen from 29% to 43%, much higher than other tech giants. This excites investors. During Nadella's tenure, Microsoft's market capitalization grew by about $2 trillion. Microsoft's price-to-earnings ratio, a measure of investors' expectations for future profits, more than doubled to 32 times during Nadella's tenure. That's higher than the average for the S&P 500 and more than all tech giants except Amazon, whose numbers are distorted by their meager gains.

Proponents say Microsoft has two major advantages when it comes to generative AI: First, the range of software it sells. It's much easier for a chatbot to peruse emails and spreadsheets and make them into slides than an AI assistant that handles different tasks for each program.

Second, Microsoft has a first-mover advantage. Microsoft is faster than its competitors in deploying AI, thanks to its partnership with Chatgpt, or perhaps because Nadella feels it has been slow to respond to smartphones and cloud computing. Whatever the reason, Microsoft's speed has made OpenAI the default choice for large companies experimenting with the technology. A recent survey of IT managers by JPMorgan Chase found that over the next three years, they expect 56% of their generative AI spending to go to Microsoft. That compares to 13% of spending going to AWS and 12% to Google Cloud.

Another survey conducted by venture capital firm Sequoia Capital of the 33 startups it invests in found that 90 percent of them use OpenAI technology. Keith Weiss of Morgan Stanley believes an ecosystem is beginning to form around OpenAI's GPT-4 model. These include consultants who specialize in OpenAI tools and advise customers on their use, as well as software sellers like HubSpot, which build custom programs using OpenAI's models.

There is some evidence that the Copilot project helped cement Microsoft's lead. In June 2022, Microsoft launched Code Generation Copilot on GitHub, a code repository that Microsoft acquired in 2018 for $7.5 billion. The model is trained using a large amount of code stored on GitHub, and it has quickly become a must-have tool for software developers.

In one survey, 90 percent of users told GitHub that Copilot had increased their productivity. The company also conducted a small study and found that programmers completed tasks 55% faster when using the tool. About 27,000 businesses subscribed to the service, double the number three months ago. Such tools are so popular in tech circles that the term "Copilot" has become short for AI assistants.

Companies testing its "productivity" software (i.e., email, spreadsheet, word processing, etc.) have reported similar benefits, Microsoft said. Kate Johnson, the owner of telecom company Lumen, described it as a "cascade of functional changes" in the way employees work. She used the Copilot-powered Microsoft Office package to review team meetings to see if quiet employees had a chance to speak. It can also record instantly and create to-do lists for attendees. Johnson added that this helps improve accountability: The tasks that employees have to complete after the last meeting "are right there, and everyone can see them."

Copilot can also work as a software coach, for example, teaching employees how to insert charts into spreadsheets. Microsoft's goal is to eventually be able to understand users' preferences and even their writing style. In his 2017 book, Hit Refresh, Nadella writes: "We hope to one day provide an efficient alter ego, an intelligent agent that understands you deeply."

Of course, all this is not cheap. If each user pays $30 per month, Copilots could mean a 52-83% premium depending on the software suite Microsoft uses. Jason Wong of market research firm Gartner said: "It's expensive compared to a license, but if it saves you some time every week, you're taking advantage."

Another way Microsoft makes money with Copilots is by acting as the underlying infrastructure. In May, Microsoft released the "Copilot stack" on Azure. This makes it easy for developers to build Copilots into their own applications or create "plug-ins" for Microsoft's Copilots. People expect more companies to use this infrastructure and send more business to Azure. Another advantage of this "platform" approach is that Microsoft may be able to strike a deal to leverage Azure customers' data to bring legal expertise to Word documents or emails. Bernstein's research notes that this creates an advantage that "competitors will find difficult or impossible to replicate."

Competitors make a difference

In the second quarter of this year, AI added about $120 million to Microsoft's cloud revenue. This number is expected to double this quarter. Weiss estimates that AI could help Microsoft add $40 billion in revenue by 2025, largely through Azure's AI tools and 365's Copilots.

Of course, such growth will not be cheap. New Street Research, a stock market analysis firm, believes that Microsoft is the largest customer of Nvidia, the world's largest seller of artificial intelligence chips. The company's research shows that Microsoft spent about $3 billion on Nvidia's AI chips in the second quarter of 2023, up from about $1 billion in the first quarter.

Microsoft CFO Amy Hood noted on a July conference call with investors that the expansion of artificial intelligence is putting pressure on Microsoft's lucrative cloud computing space. This is offset by more efficient data processing, she said. Scott Guthrie, Microsoft's head of cloud and artificial intelligence, said: "We are seeing that the cost of inference (associated with asking AI models) is falling, and we expect this trend to continue and models to become more accurate and efficient."

Even if spiraling costs are contained, there are plenty of other risks. Competition has come to a fever pitch, with one battle being the $340 billion commercial software market. In May, Google announced its Copilots version of Duet for Workspace. Last week, Google released new features that allow its chatbot Bard to access users' Gmail inboxes and Google Docs.

Software giant Salesforce also owns Einstein. Messaging app Slack, a subsidiary of Salesforce, owns Slack gpt. ServiceNow's software helps companies manage their workflows, and it has Now Assist. Zoom offers Zoom Companion. Intuit is selling Intuit Assist. Startups such as Adept and Cohere also offer AI assistants. OpenAI launched Chatgpt for enterprises in August this year.

Providing the infrastructure to underpin such AI products will be another battleground. Both AWS and GCP offer AI models similar to OpenAI. Analysts suspect that these competitors are more experienced than Microsoft in deploying specialized AI chips. In August, Google released a new AI chip for training large language models.

Be prepared to face three major challenges

Microsoft major shareholder T. According to Ken Allen of Rowe Price, all generative AI tools, including Copilots, must be prepared for the following challenges:

The first is the legal issue, where most AI models are trained on copyrighted material that users may inadvertently copy. The head of a large oil and gas services company said he blocked employees from using GitHub's Copilot after his company was accused of copyright infringement last November. Microsoft agreed to pay customers legal fees related to Copilots, provided they used Microsoft's security features, such as content filters.

Second, large models can also go wrong. Microsoft reduced these problems by training them to have accurate, up-to-date information and include more citations. But that hasn't stopped it from mistaking journalists for CEOs. Jared Spataro, who oversees Microsoft's productivity software, said Copilots needed a "whole new way of working" in which machines could help you produce more, "but it wasn't always right". Humanity must be vigilant about this and correct it if necessary.

The third issue is data governance, which is ensuring that only the right employees have access to the right information. One analyst noted that some early adopters of Copilots found "very scary" results. For example, personal files or confidential messages appear in the search.

It is almost certain that Microsoft will be accused of abusing its market power. During the last period of its rise in the late 90s, endless competition plagued it. The company is already fighting on many fronts. In August, after Slack's complaint sparked an EU investigation, Microsoft announced it would "spin off" Teams from its package. Customers also complained that Microsoft's software licensing prompted enterprises to use Azure instead of AWS and GCP. Microsoft President Brad Smith called it a "legitimate concern," and Microsoft said it had made changes. But in June, Google submitted comments to an investigation by the U.S. Federal Trade Commission (FTC), alleging that Microsoft was "locking customers" with unfair licensing terms.

With the popularity of artificial intelligence software, such disputes will undoubtedly surge. For example, if Windows Copilot directs users to Outlook instead of Gmail, antitrust officials may step in. The result could be a weakening of Microsoft's ability to leverage a wide range of software products to make Copilots more powerful, which is one of Microsoft's major competitive advantages.

Even so, Microsoft remains in a strong position. Microsoft missed out on the smartphone boom and was slow to grasp the potential of cloud computing. Today, it finds itself poised to take advantage of a technology that could change the world of work. It must strike a delicate balance between moving faster than competitors while ensuring that its foray into AI doesn't upset regulators, hurt profits or annoy customers. If that fails, a large number of competitors are ready to take Microsoft's place. But if successful, the rewards will also be enormous. Copilot will be the captain who will dominate Microsoft's destiny. (Text/Golden Deer)