It's Microsoft's turn to prove worthy of being the world's number one market capitalization
Image source@Visual China
Titanium Media Note: This article comes from the WeChat public account Barron's (ID: barronschina), the author | Andy Sevo, ed Guo Liqun, Titanium Media is authorized to publish.
At the recent World Economic Forum Annual Meeting, Microsoft (MSFT) CEO Satya Nadella and his partner, OpenAI CEO Sam Altman, introduced the future of generative AI and how it will dramatically improve human lives, until the moderator steered the conversation to the question of AI commercialization, and the moderator asked bluntly, "Do you make money?"
This is a very good question, but Nadella and Ultraman did not answer it directly. Altman replied first, "Obviously, Microsoft wants to make a lot of money, and Satya knows better than I know who can make money." ”
Then Nadella said, "After you work with a platform, if you don't make as much money through that platform as you did before the partnership, then you can't be a successful platform company." He was referring to a business model in which a company makes money through multi-party trading.
Nadella's answer underscores Microsoft's ambition to become a platform giant like Amazon, Apple and Alphabet, but more importantly, it touches on three key questions that Microsoft shareholders (and potential shareholders) want to know: How does Microsoft make money with AI, how much does it make, and when does it start making money?
Nadella's answer also shows that the answers to these questions are not clear.
On January 25, Microsoft's stock closed at a record $404.87, with a market capitalization exceeding the $3 trillion mark for the first time. Microsoft has outperformed the S&P 500 over the past one, three, five, and 10 years, and would be worth more than $22 million today if investors had paid $5,000 for Microsoft stock when it went public on March 13, 1986.
The numbers are pretty, but there are two periods that are particularly noteworthy – the last 10 years and the last 14 months. First, Microsoft's stock price has risen 10-fold over the past 10 years (1,000 percent, compared to 161% for the S&P 500), exactly 10 years since Nadella became CEO on February 4, 2014.
The long journey of the "comeback".
Nearly 25 years after Bill Gates stepped down as CEO, Microsoft and the Microsoft stock price have reached new heights under the leadership of Satya Nadella.
Building Azure, a cloud platform, is Nadella's main way of helping Microsoft "make a comeback." According to research by Jefferies analyst Brent Thill, Azure's market share has risen from 18% in 2016 to 37% this year, with current revenues of $64.5 billion.
"I haven't looked back on the last 10 years, this year is my 32nd year at Microsoft, my second year in AI, and during those years, I've experienced three other paradigm shifts: PC client-server, internet, mobile and cloud, and the fourth is AI, so I'm trying to relive how I ran the company in the second year of the other three paradigm shifts," said the 56-year-old. (Nadella did not speak to Barron's, and all comments in this article are from his public remarks at the World Economic Forum's annual meeting.) ）
This brings us to the period of the last 14 months. Since ChatGPT's release on November 30, 2022, Microsoft's stock price has soared 66%, compared to a 22% gain in the S&P 500 over the same period. For a stock with such a large market capitalization, such an increase is quite staggering.
But the latest rally, driven by investors' expectations of a significant increase in incremental revenue and profits from AI, may materialize, but no one knows what will happen in the end.
Mac or PC?
In competition with Apple, the rise of cloud and artificial intelligence has given Microsoft an edge. Earlier this year, Microsoft overtook Apple as the world's most valuable company.
Note: Calendar year 2024 estimates. Net cash as of September 30, 2023. Source: Bloomberg, FactSet, company earnings
Microsoft's stock is definitely not cheap. Jefferies' Thiel noted that Microsoft's forward P/E ratio of 32.6x is at an all-time high, while the Nasdaq Composite Index is trading at 27.1x forward P/E. Microsoft is Thiel's top pick stock for 2024, and he gives a price target of $450.
Long-time Microsoft investors may remember that when Microsoft's stock price rose sharply during the dot-com bubble 25 years ago, they faced a similar dilemma — should they sell their shares? After peaking at $59.96 per share in December 1999, the stock price bottomed out at $15.15 in March 2009, wiping out nearly 75 percent of its market value, and it was not until October 2016 that the stock closed above its 1999 peak.
But that's no longer the case. In 2000, Microsoft was at a disadvantage in the upcoming phone cycle. (The BlackBerry came out in 2002, followed by the iPhone.) A Microsoft executive said to me, "We've completely missed the opportunity that mobile phones bring." Another difference is that when the stock price peaked in January 2000, Bill Gates stepped down as CEO, and this time, Nadella said he had no plans to leave.
In fact, one of Microsoft's great strengths is having an experienced management team, including Nadella. CFO Amy Hood has been with Microsoft for 21 years, and co-founder Gates remains a technology advisor to the company. And Brad Smith, Microsoft's lead attorney for 30 years, who helped settle Microsoft and the federal government in antitrust litigation in the late '90s and early 21st century, and now serves as Microsoft's vice chairman and president, the company's No. 2 man.
Smith and Microsoft learned Washington's way of doing things from these trials and tribulations and stepped up their company's lobbying efforts years ahead of other tech giants, with Smith described by the New York Times as a "tech industry ambassador." Lawyers representing other companies and critics of Silicon Valley say Microsoft's influence and "fingerprints" in Washington are everywhere, whether it's Biden's executive order on artificial intelligence, Epic Games' lawsuit against Apple, or Jonathan Kanter, assistant attorney general of the Justice Department's antitrust division, who served as Microsoft's lawyer during his private career. A lawyer for one of Microsoft's competitors complained, "Microsoft has taken care of everything." ”
However, Microsoft has recently come under scrutiny from regulators in the US and Europe for its acquisition of Activision Blizzard and its partnership with OpenAI, with some insisting that OpenAI is now controlled by Microsoft. "The two companies are obviously separate, there's no question about that, we're partners, and if you go and look at the AI ecosystem, you'll see that Microsoft has a very strong and respectable vertically integrated competitor, and that's Google," Smith told me. I think the first question that people should ask is: should we encourage businesses to have partnerships like this? It's very important to build partnerships because if we don't, there's only one company doing AI, just like there was only one company doing search in the past. ”
There is no doubt that Microsoft's partnership with OpenAI and its ChatGPT product has given Microsoft a leading position ahead of Google, which has been focusing on artificial intelligence for years. Google has developed key AI technology and shared it publicly, and this technology was crucial to the founding of OpenAI. OpenAI was founded in 2015 and its investors include Reid Hoffman, Elon Musk, Peter Thiel, and Altman, who became CEO in 2019.
The complementarity of the need for sophisticated, cutting-edge software (OpenAI) and powerful computing power (Microsoft) for AI development is the basis for this symbiotic partnership. In July 2019, Microsoft invested $1 billion in OpenAI, and a year ago it invested an additional $10 billion.
Microsoft is in the early stages of infusing OpenAI's technology into all of its products. Starting with the coding platform GitHub, it's now rapidly deploying AI-enhanced capabilities to applications like Azure and Excel through Copilot. "Bill Gates once said that the personal computer age was characterized by the accessibility of information, and the artificial intelligence era is characterized by the accessibility of knowledge or professional skills," Nadella said. ”
The transformation was not an easy task for Microsoft, which is huge. Like Alphabet, Apple, Amazon, and Meta Platforms, Microsoft has grown organically through acquisitions large and small. (According to Microsoft's website, 230 acquisitions have been made since 1994.) The direction of the company's development and organizational structure is influenced by these internal and external sources of growth.
Microsoft now has three business units: Productivity and Business Processes, which includes Microsoft 365 (Word, Excel, PowerPoint, and Outlook) and Microsoft Teams and LinkedIn; , which includes Azure and SQL and GitHub, and more personal computing, which includes Windows operating systems, gaming platforms Xbox and Activision Blizzard, devices such as Surface, and search engines Bing and Microsoft News.
Four years ago, all three businesses were the same size (each with revenues of around $47 billion), but that has changed now, and the cloud business has since grown by an average of about 22 percent per year. In 2023, the cloud business contributed $87.9 billion of total revenue of $211.9 billion. Thiel expects revenue from the business to reach around $119 billion in 2025.
Dan Ives, an analyst at Wedbush, said: "Azure and the addition of AI capabilities will give Microsoft a huge advantage. Ives called it "Microsoft's iPhone moment" and believes that Microsoft is on track to generate $25 billion in additional cloud revenue from AI over the next two years. "We think that for every $100 Microsoft spends on Azure, it gets $35 to $48 in incremental revenue from AI," Ives said. ”
"Microsoft is still in the early stages of AI revenue recognition because most of the Copilot AI tools are not yet widely available," Teal said. Revenues will grow slowly and steadily, with more significant growth in 2025. ”
Microsoft says all systems are ready. Takeshi Numoto, Chief Marketing Officer, said: "Our products have a huge appeal to customers, and think about some of the customers that we've already announced: Visa, Honda Motors, Accenture, PwC and KPMG, have just launched products with availability restrictions that many customers want to remove. Numamoto said Microsoft had already done so on January 16.
However, even those who are bullish on Microsoft have issued warnings. "Microsoft was the first company to hype up AI more than any other company, so it got a lot of attention, and the risk of doing that is, what if there's a 'thunder and a little rain'? ”
Thiel also believes that Copilot's pricing may not meet expectations, and while it will still bring a 10% to 20% increase in Microsoft's software prices, he doesn't think it will be the 100% increase he had previously expected. Ken Numamoto said Microsoft doesn't see unusual headwinds in terms of pricing.
How willing and fast customers will adopt AI is another question.
"There's a lot of hype around AI, people are trying to figure out how to use it, how to redo internal processes takes time, and finding enough people with technical expertise is a constraint that slows down deployment," said Trish Damkroger, senior vice president of AI solutions at Hewlett Packard Enterprise. ”
Last year, Morgan Stanley released a ChatGPT-based AI tool that financial advisors can use to access the company's library of research reports, but an employee at Morgan Stanley told me that it doesn't seem like a priority for the company right now, saying, "We've been getting a lot of emails about it, but lately no one has been emailing and no one is talking about it." "Other employees allegedly expressed dissatisfaction with the accuracy of this tool. Roger McNamee, a tech investor, said: "A lot of apps will just give you a plausible answer, but the facts are very important, especially in the business world. ”
Morgan Stanley told Barron's: "The feedback from the AI assistant has been overwhelmingly positive, user engagement has been high, and we've seen a significant improvement in accuracy compared to previous knowledge management processes." ”
Microsoft and Altman are wary of how quickly the AI revolution is unfolding.
When Marc Benioff, CEO of Salesforce, asked Altman at the World Economic Forum what he wanted to achieve in the next five years, to which he replied that he wanted AI to be used for scientific discovery, saying, "Whether it's in five years or eight to 10 years, it will eventually be achievable." ”
At the same time, Nadella and Microsoft scientists presented an artificial intelligence project that designed a battery that replaced lithium with common sodium, reducing lithium use by 70 percent. This sounds like a major breakthrough, but when I mention commercialization to Microsoft's scientists, it doesn't sound like it's likely to happen anytime soon.
"I think 2024 could be a year of massive development [of artificial intelligence]," Nadella said. Note that he didn't mean "will make money."
Some Wall Streeters have taken notice.
Glenn Hutchins, a tech investor, said: "ChatGPT is a product demonstration that has captured the imagination of the world, and now we are in the hype cycle of artificial intelligence, which will go through its own 'hopeless trough' and then reappear in widespread adoption. ”
What does all this mean for investors? Gene Munster of Deepwater Asset Management said: "If investors are looking at a one-year outlook, it doesn't make much sense to buy Microsoft shares now because expectations have gone up." In terms of artificial intelligence, Microsoft will not have much breakthrough this year, and the time point of the breakthrough will be in the next three to five years. ”
For most companies at the moment, AI is not a "must-have" or even a "want to have", AI may be as ubiquitous and promising as Nadella and Altman predicted, and may even be realized soon, but whether and when this vision can be realized, it will go through a long upgrade cycle, so investors should perhaps take a wait-and-see approach. It's always better to do one thing right than to act too soon.
To have some fun, I asked ChatGPT if Microsoft's generative AI business could be successful?
"I don't have the ability to predict the future, including predicting the success of a particular company's generative AI business. The success of Microsoft or any other company in this area will depend on various factors such as the quality of technology, innovation, market demand, competition, and strategic decisions. ”
It stands to reason that AI is not in vain.