Google & Microsoft – Scroogled again

Microsoft is really getting under Google’s skin.

• Microsoft continues to leverage OpenAI to get under Google’s skin and this quarter one can see some impact of this in the numbers.

Microsoft FQ1 24 – AI Brand power

• Microsoft reported excellent results where its cloud business reaccelerated revenue growth and the rest of its business remained very robust even in the face of a weak macro outlook.
• FQ1 24 revenues and EPS were $56.5bn / $2.99 ahead of estimates of $54.5bn / $2.65 where Microsoft is capitalising on the popularity of all things OpenAI to bring in customers.
• The star of the show was Azure where growth accelerated to 29% YoY compared to 26% in FQ4 23 which is an impressive feat given what Google (below) is experiencing and the general macro-driven slowdown.
• Microsoft also thinks that it has gained market share in business applications during the quarter which combined with a steadier-than-expected PC market underpinned the excellent results.
• What really seems to have underpinned Azure is the fact that many customers signing up to Azure are also taking OpenAI tools as part of their package in a sign that the OpenAI association is paying dividends.
• Microsoft intends to integrate OpenAI’s AI into all of its products over time which will be a big draw in the short-term but also underlines my view that Microsoft will have to acquire OpenAI at some point as this is a dependency that cannot safely remain external to the company.
• Guidance for FQ4 24 was steady with Azure expected to maintain its current levels of growth which is being increasingly underpinned by OpenAI’s brand recognition and the tools that it offers.
• The days of Microsoft being a value play are long over and the more that AI hype stretches its multiple, the less inclined I am to like it.
• If I held it, I would have sold it a long time ago and I would continue to look elsewhere.

Google Q3 23 – Search is safe.

• Alphabet reported disappointing results as its cloud division continues to lose market share potentially opening up a value opportunity should one believe that Google still has the AI goods and that search is safe.
• Q3 23 revenues ex-TAC / EPS were $64bn / $1.55 which was ahead of estimates of $63bn / $1.45.
• Advertising revenues performed well at $44bn compared to estimates of $43bn but these days, everything is about AI and here Alphabet continues to flounder when it comes to marketing.
• Google Cloud missed expectations reporting growth of 22% YoY and profit of $266m compared to expectations of $434m.
• There are two main drivers in the cloud at the moment.
• The positive end is anything to do with AI while elsewhere companies are optimising their spend given the current environment of cost control and efficiency.
• Microsoft is benefitting from the former more than offsetting the latter while Google is not which is why Google called out customer spend optimisation and reported weaker growth despite being a much smaller business.
• This was further tempered by management commentary which aims to continue focusing on efficiency and maximising the returns the company earns on its investments.
• The shares fell by 6% in after-hours trading reflecting the market’s concern that OpenAI’s impact on Google’s core search business.
• There is no evidence that OpenAI and generative AI in general are in a position to replace search anytime soon.
• For example, both Bing powered by GPT-4 and Bard powered by PaLM 2 are unable to answer even the most basic factual inquiries accurately.
• For example, in 2022 Booz Allen derived 97% of its revenue from the US government but both Bard and Bing think the number is 93% and get the total revenue number for 2022 wrong.
• A simple Google search using the same inquiry terms gets it right the first time and as the top hit.
• Furthermore, the search market share numbers show no impact whatsoever from Bing or generative AI over the last 12 months further underlining my view that there is no immediate threat to search from generative AI from OpenAI or anyone else.
• Hence, I think that search will continue to outperform the market’s expectations and the more Google fluffs its marketing around its AI prowess, the more I am inclined to look at taking a position.
• It has not underperformed anything like enough yet, but it is one I am keeping an eye on for a narrative-driven meltdown not supported by the numbers.