Second only to NVIDIA, is the market favoring Microsoft?

In the eyes of investors hoping to benefit from the prosperity of AI, Microsoft ranks second only to NVIDIA in terms of low positions. However, its high valuation suggests that the market underestimates the challenges it may face in the process of AI expansion, including the possibility of declining profit margins or losing market share in the enterprise software field.

For investors who are looking to bet on large tech companies creating growth through AI, it is better to buy companies like Meta or Amazon that may also benefit and have lower prices.

There is no doubt that Microsoft will benefit greatly from AI, but this may only be because it holds equity in OpenAI, has the right to share the company's profits, and is its exclusive cloud provider. These expectations are already fully reflected in Microsoft's stock price, meaning that any unfavorable factors could pose a risk of price decline.

Standard & Poor's Global Market Intelligence data shows that Microsoft's current forward P/E ratio is close to 24 times.

Apart from the bull market at the end of 2021, Microsoft's valuation has never reached such high levels since the early 21st century. The company's current P/E multiple is also much higher than Meta, Amazon, and Google's parent company Alphabet, which range from 13 to 15 times.

Microsoft's AI Risks

Microsoft's AI strategy is not cheap. In the most recent quarter, the company spent a record $14 billion on capital expenditures, mainly to establish and operate infrastructure related to AI models in its vast Azure cloud computing division. Executives have stated that they expect this substantial expenditure to further increase next year.

To justify this expenditure, AI will need to drive significant revenue growth for Microsoft and ultimately achieve profit growth.

Revenue acceleration has already begun. Microsoft's CFO Amy Hood stated in the latest quarterly earnings call in April that AI accounted for 7% of the 31% growth in Azure and other cloud services.

However, Piper Sandler analyst Brent Bracelin pointed out that the revenue profit margin of Azure is not as high as software revenue, as renting servers is a cost-intensive business.

More importantly, this 7% growth may partly come from OpenAI, whose ChatGPT chatbot runs only on Azure.

Of course, since Microsoft does not disclose Azure's revenue and only provides a percentage growth figure, it is complex to determine how much revenue OpenAI generates.

Nevertheless, to some extent, Azure's AI growth comes from OpenAI, which is crucial. The Information also reported last week that OpenAI only pays Microsoft enough fees. This indicates that Microsoft does not profit from OpenAI's incremental revenue.

Furthermore, the relationship between the two companies may alienate some customers. For example, a software buyer told AlphaSense that they chose to use Amazon's Bedrock service to access generative AI models instead of Microsoft's Azure OpenAI service One key concern expressed by this customer is that, unlike Amazon, Microsoft may share its proprietary data with OpenAI, which could use this data to train its models.

A Microsoft spokesperson stated that the company "has not shared any customer's personal data with OpenAI for model training." The spokesperson emphasized that Microsoft will not use any content created by customers in its productivity software to train large language models.

Of course, part of Azure's growth may come from other customers. For example, Microsoft offers a data analytics tool called Synapse in Azure, which helps customers unify different datasets - a prerequisite for feeding data into AI models.

Even though OpenAI currently accounts for a large part of Azure AI growth, this situation will not last forever. Nevertheless, investors will still be eager to understand the reasons driving Azure's growth.

Software Uncertainty

Microsoft's software business, which accounts for a third of its revenue, also needs a boost from AI.

Microsoft says this is happening. As of the quarter ending in March, the paid users of Microsoft's AI code assistant GitHub Copilot under the cloud computing department reached 1.8 million, a 35% increase from the previous quarter.

At the same time, Microsoft says nearly 60% of Fortune 500 companies are using its AI chatbots embedded in enterprise software suites, including tools like Excel and Word. Employees using these features have to pay an additional $30 per year.

However, Abdullah Al-Rezwan, founder of stock research firm MBI, says it is currently unclear how much revenue Microsoft actually generates from selling these subscriptions.

Al-Rezwan said, "I've seen both positive and negative sides of Copilot and how it's evolving, so it's hard to have a firm belief in it."

He added, "The market believes that Copilot's trial will be successful, and these incremental features will be widely adopted, which will increase Microsoft's APRU."

For Al-Rezwan, one concern is that Microsoft is facing increasing competition in this area, including from Google.

He believes that Google's productivity suite Workspace could erode this leading position in the future, as Google executives inject AI chatbots and features into each product.

Al-Rezwan said, "Seven or eight years ago, if you wanted to (develop new software), you needed a lot of engineering resources to complete a task with uncertain results."

Google vs. Microsoft

However, Al-Rezwan believes that AI makes software development easier and could enhance Google's ability to compete with Microsoft in the enterprise software field Of course, Google has been providing office software for many years, such as the commercial version of Gmail in Google Workspace.

According to Gartner's data, last year Google Workspace had a market share of 16.1% in the office software field (measured by revenue), while Microsoft held 83.2% of the market share.

Recently, Google has added the Gemini AI chatbot to its office suite. Although Google may make progress in the software field, investors are concerned that AI chatbots that can answer questions may undermine its cash cow: the web search business.

This is why both Al-Rezwan and New Era Funds' Chief Investment Officer Richard Jarc have expressed more confidence in Meta's prospects, believing it is a better AI beneficiary worth supporting today than Microsoft or Google.

The ways in which Meta can make money from its AI products may not be so clear. But Jarc believes that digital advertising will be one of the first areas to benefit from AI, as it allows advertisers to target customers more accurately through real-time customized ads.

This is something Meta has not been able to do as easily as Google in the past, as Meta displays ads in individuals' social media feeds rather than being able to provide ads based on specific questions users ask in searches. Jarc believes that generative AI tools can make it easier to create new ad campaigns and can save a significant portion of the ad budget that would have otherwise gone to designers and agencies, enabling advertisers to invest more on Meta.

Furthermore, he added that Google is the company with the highest market share in the digital advertising market, so it is expected to suffer greater losses than the second-largest company, Meta. In addition, Meta's forward P/E ratio is 13.2 times, the lowest among the tech giants investing heavily in AI