Microsoft is in the early stages of infusing OpenAI’s technology into all of its offerings. How much will it make from AI, and how long will it take to do so? By Andy Serwer
Last week at the World Economic Forum’s annual meeting in the rarefied Swiss air of Davos, a select group of swells were packed into a converted storefront listening, rapt, to Microsoft CEO Satya Nadella and his high-profile partner Sam Altman, CEO of mega start-up OpenAI, when the discussion took a “get real” turn.
Nadella, the establishment figure, dressed casually in gray slacks and a sweater, and Altman, the disrupter, wearing a suit, were talking about the great promise of generative artificial intelligence — this year’s “it” topic at Davos — and how it will vastly improve the lot of humanity. That is, until the moderator steered the conversation in a commercial direction.
“Do you guys make money?” she baldly asked about their AI endeavors.
It’s a good question — and one to which Nadella and Altman didn’t directly respond.
Altman started. “Obviously, Microsoft likes to make a ton of money,” he said. “Satya’s going to understand better than I will who’s gonna make money.”
Then Nadella: “You can’t have a successful platform company if the money made on the platform is not greater than the money made by the platform, ” he said, referring to the business model where a company profits from transactions between multiple parties.
Nadella’s response underscores Microsoft’s ambitions to become more of a platform goliath like its Magnificent Seven brethren Amazon.com, Apple, and Google parent Alphabet. But more important, it speaks to three critical questions for Microsoft shareholders (and would-be shareholders): How does Microsoft make money from AI, how much will it make, and when?
It also suggests that the answers to those questions aren’t clear.
In case you haven’t noticed, Microsoft has just been killing it, with its shares closing Thursday at a record $404.87, hovering around a $3 trillion market cap, and going back and forth with Apple as the most valuable company on the planet. MSFT stock has run the table, outperforming the S&P 500 index over the past one, three, five, and 10 years. If you had bought $5,000 of the stock at its IPO on March 13, 1986, it would be worth over $22 million today. (Damn!)
That’s a lot of shiny, happy numbers, but it’s worth focusing on two periods in particular — the past decade and the past 14 months. First, over the past 10 years, Microsoft stock is up — poetically — almost exactly tenfold (or 1,000%, versus 161% for the S&P 500), which neatly matches the tenure of Nadella, who became CEO on Feb. 4, 2014. That run speaks to the remarkable work the then little-known Microsoft engineer has done reviving the company from its moribund state. (You also may recall that in late 2015, my Barron’s colleague Alex Eule presciently anticipated the Nadellaissance in his article “Microsoft: Faster, Stronger, Better.”)
Nadella brought Microsoft back mostly by building out the company’s Azure cloud platform, which, according to Jefferies analyst Brent Thill, has grown market share from 18% in 2016 to 37% this year, and now has $64.5 billion in revenue — mostly at the expense of Amazon Web Services. Soaring morale and buzz have ensued. (“We haven’t had this kind of excitement since I don’t know when,” said a longstanding Microsoft exec at the Davos event.)
Nadella, 56, isn’t eager to harp on anniversaries — “I haven’t really reflected on the 10 years,” he says. “This is my 32nd year at Microsoft, and it’s the second year of AI. My years have been punctuated by three other paradigm shifts: PC client-server, the web, and mobile and cloud. Now the fourth is AI. And so I’m trying to go back to learn how to operate in year two of the other three paradigm shifts.” (Nadella declined to speak with Barron’s. All comments from him in this article come from public appearances in Davos.)
Which brings us back to the past 14 months. Since ChatGPT was released on Nov. 30, 2022 — an event Nadella and others say is commensurate with the introduction of the first widely adopted internet browser, Mosaic, in 1993 — Microsoft stock has been riding an AI rocket ship. Over this period it has soared 66%, versus 22% for the market, a stunning move for such a big market-cap stock.
But this latest leg up is really in anticipation of a significant jump in incremental revenue and profits coming from AI. It might pan out, but no one really knows.
The stock certainly isn’t in the bargain basement. According to Jefferies’ Thill, who has Microsoft as his top pick for 2024 with a $450 price target, the company’s forward price/earnings ratio now stands at 32.6, versus 27.1 for the Nasdaq Composite, historically high for the stock. (The company will announce its fiscal 2024 second-quarter earnings this coming Tuesday.)
Microsoft investors with long memories may remember facing an eerily similar dilemma 25 years ago, after the stock climbed dramatically during the internet bubble — should they sell their position? Back then, they would have been wise to do so. After peaking in December 1999 at a split-adjusted $59.96, the stock bottomed out in March 2009 at $15.15, losing nearly 75% of its value. Shares wouldn’t close above that 1999 peak until October 2016 — truly a lost epoch for MSFT shareholders.
Things are different today, though. In 2000, Microsoft was poorly positioned for the mobile phone cycle, which was about to kick off. (The BlackBerry phone appeared in 2002, followed later by the iPhone.) “We totally missed mobile,” a senior Microsoft executive acknowledged to me. Another contrast is that in January 2000, right as the stock topped out, Bill Gates stepped down as CEO. Nadella says he isn’t going anywhere.
In fact, one of Microsoft’s great strengths is its experienced management team even beyond Nadella. Chief Financial Officer Amy Hood has been at the company for 21 years, and co-founder Gates is still a technology adviser. Then there’s Brad Smith, a 30-year veteran and the company’s top lawyer, who helped defend Microsoft against the federal government’s antitrust case in the late 1990s and early 2000s. Smith is now vice chair and president — the company’s No. 2 executive.
From those trials and tribulations, Smith and Microsoft learned the ways of Washington and beefed up the company’s lobbying efforts years before the other tech giants. Smith, a consummate insider (he’s on the boards of Netflix and Princeton University, an author, and a podcast host), was described as “a de facto ambassador for the technology industry at large, ” by the New York Times. Attorneys representing other companies and Silicon Valley critics say that Microsoft’s Washington influence and fingerprints are everywhere — from Joe Biden’s executive order on AI, to Epic Games’ litigation against Apple, to a federal government case against Google brought by Jonathan Kanter, assistant attorney general for the Department of Justice Antitrust Division, who previously represented Microsoft in private practice. “Microsoft has this whole thing wrapped up,” complains an attorney for a competitor.
Still, Microsoft has attracted regulatory scrutiny recently in the U.S. and in Europe with its acquisition of Activision Blizzard and its relationship with OpenAI, which some maintain is controlled by Microsoft. “The companies are clearly separate,” Smith tells me. “That’s unquestionable. We are partners. If you look at the AI ecosystem, there’s one very strong and respectable competitor that is vertically integrated. That’s Google. I think the first question people should ask is, do we want to encourage partnerships? It’s critical that we do so because if we do not, there’s only going to be one company that does for AI what that one company did for search.”
There’s no question that Microsoft’s partnership with Altman’s OpenAI and its ChatGPT products has put the company in the catbird seat, surpassing Google, which has been working intently on AI for years. Google had developed critical AI technology that it shared publicly; tech that became key to the formation of OpenAI. Founded in 2015, OpenAI counted Reid Hoffman, Elon Musk, Peter Thiel, and Altman among its investors. Altman would become CEO in 2019.
AI development entails complex, cutting-edge software (OpenAI has that) and requires massive computing power (Microsoft has that), and those complementary capabilities became the basis of the symbiotic partnership. Microsoft first invested $1 billion in OpenAI in July 2019 and then anted up a staggering $10 billion a year ago. (Late last year there was a management kerfuffle where the OpenAI board sought to dismiss Altman. Microsoft supported Altman, and it was the board that essentially got the boot.)
Microsoft is in the early stages of infusing OpenAI’s technology into all of its offerings. The company started with coding platform GitHub, and it is rapidly deploying AI enhancements into Azure and applications software such as Excel through a pan-platform rubric called Copilot, a sort of AI assistant to help customers analyze data, optimize inventory, or write a report. “Bill Gates said that the PC era was information at your fingertips,” says Nadella. “This [AI] is knowledge or expertise at your fingertips.”
Microsoft is a big company to transform. Like Alphabet, Apple, Amazon, and Facebook parent Meta Platforms, Microsoft has grown organically and through scads of acquisitions big and small. (The company lists 230 since 1994.) Both those internal and external sources of growth have informed the company’s direction and organization.