Reaction to the big tech results on Tuesday night was to sell Microsoft and Alphabet/ Google, even though both companies beat earnings estimates. It’s easier to understand the sell off in Google’s share price, and Microsoft hovered between small losses and gains. The problem for Google is that they don’t have an AI product right now, and Tuesday’s earnings highlighted this. In contrast, Microsoft has AI products that are generating revenue and are expected to continue to do so in the future, so we expect Microsoft’s share price to outperform Google in the coming months.
The issue for Microsoft is that its stock has had a strong run on the upside in recent months, and even though Microsoft beat earnings expectations, a lot of the good news is already priced in. Forward guidance was decent, and this has helped Microsoft’s share price recover after an initial sell off. The market liked the forecast for Intelligent Cloud revenue of $26bn – $26.3bn, the company also expects operating margin expansion of 1-2% YoY. Some analysts sound concerned that this may not be high enough due to the huge investment in AI in recent years, and this could keep a lid on the share price for now, especially as there are fears about concentration in the S&P 500, with 2024’s rally being led by the Magnificent 7. There may not be much to criticize in Microsoft’s earnings report, however, the forward guidance has not set the world alight.
How tech giants are monetizing AI
While these earnings reports may not have set the market alight, they are interesting for what they tell us about how the tech giants can monetize AI. Looking at Microsoft first, revenue was $62bn, up 18%, and net income was $21.9bn, an increase of 33%. These were a solid set of results. The key takeaway from Microsoft’s CEO Satya Nadella, was his comment that Microsoft has ‘moved from talking about AI to applying AI at scale.’ Due to Microsoft’s early adoption of AI, analysts can break out the contribution of AI to revenues at this early stage. Tuesday’s earnings report was a key test of how AI can boost revenues for companies that infuse AI in their products, rather than create the hardware needed to make AI possible like Nvidia.
Regarding Microsoft’s AI infused products, Copilot was recently rolled out. It is a subscription-based AI tool that allows users to generate emails, meeting notes etc., and is designed to boost workplace productivity. The earnings report did not explicitly break out Copilot revenue, however, Microsoft Office’s commercial products and cloud service revenue increased by 15% last quarter, driven by a 17% increase in Office 365 Commercial revenue. These numbers suggest that consumers have been keen to adopt Copilot. Microsoft’s forward guidance was also supportive for Copilot, and it expects further revenue growth, and Office 365 growth is expected to expand by 15% next quarter. Azure revenue growth is expected to remain stable around the same level as the December quarter.
Microsoft’s head is in the cloud
Azure, Microsoft’s cloud business, saw revenue growth of 30%, higher than the 27.5% growth rate expected. This earnings season is all about AI, and Microsoft is in a sweet spot. Not only is its Azure cloud business crucial to AI, since AI functionality requires cloud services, but it also creates popular consumer products that are infused with AI capability. The large expansion in Azure revenues suggests that customers are already buying cloud services in anticipation of adopting AI services in future, which is positive for the future of Microsoft’s share price. These results could set the tone for expectations about AI for the rest of the year.
Microsoft’s acquisition of Activision is also starting to pay off, and it made a huge impact on X-box content and service revenue, which jumped by 61% last quarter, 55% of this was down to Activision.
Google: An advertising company with AI ambitions
Google also reported earnings on Tuesday night. Revenue was higher than expected at $86.3bn, vs. $85.3bn expected a 13% increase YoY. Earnings per share came in at $1.64 vs. $1.59, so profit growth is moving in the right direction at Google, but the stock price slumped by more than 5% after the market closed on Tuesday night. The market may have been put off by the CEO’s statement that said the company is continuing to re-engineer its cost base to give it room to expand into other growth opportunities. This suggests that Google has more advances to make on this. We would note that Google saw stronger revenues in Google search, YouTube ads and Google advertising relative to 2022. However, ad revenue was weaker than expected, and at heart Google is considered an advertising company with ambitions to move into the AI space. This is why the share price tanked after the results were announced, as the market does not have much patience for earnings misses from big tech firms.
Regarding Google’s push into AI, there was some good news. Its services and cloud business also expanded strongly. Google’s cloud business saw revenues rise by 26%, which is a positive foothold for Google into the cloud space, which is vital for AI functionality. Google doesn’t provide guidance, but it did say that Gemini Ultra, its AI product, is coming soon, however, they provided no dates or numbers around this or the potential for monetization. The market is filling this communication vacuum with selling pressure.
The US remains at the centre of AI space
Overall, Microsoft results, and to a lesser extent Google, show that the US is ahead when it comes to AI. We are entering the knowledge age, and AI will impact all areas of the global economy. The fact that the US has the companies with the best capabilities in this area suggests that the S&P 500 should continue to do well, even if there is a pullback in the short term as the market frets about concentration risk.
A last word on Elon Musk
Tesla shares have fallen more than 3% after a judge voided Elon Musk’s $55bn pay package, after an investor challenged the pay packet saying that it was excessive. This means that Tesla’s board now needs to come up with a new package for Musk. He has already asked for a larger stake in Tesla and has threatened to embark on AI projects outside of Tesla if his demands for a greater stake are not met. Tuesday’s ruling could make it harder for Tesla to please Musk in the long term, which adds extra uncertainty to the company’s future.