Microsoft Draws Analyst Plaudits After Earnings Report

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Microsoft, Alphabet, Amazon, & Meta will win the AI arms race: Analyst

Artificial intelligence adoption becomes a tighter race as tech companies continue to cite AI as growth drivers in their earnings. Jefferies Senior Analyst Brent Thill joins Yahoo Finance Live to discuss the path forward in AI adoption for companies such as Google-parent company Alphabet (GOOG, GOOGL), Snap, and Microsoft (MSFT), which Thill notes the latter's AI adoption will be "more of a 2024 event than a [2023] event."

- Well, as we've been talking about tech companies, like Google, Meta and Microsoft are moving fast on artificial intelligence, Alphabet is looking to lead in the AI arms race all of them are looking to lead. But in the Google parent company's earnings call, CEO Sundar Pichai said our continued leadership in AI and our excellence in engineering and innovation are driving the next evolution of search and improving all our services.

Let's bring in Brent Thill, Jefferies' senior analyst to weigh in here. Who do you think is going to be on top here? Or is it even sort of a zero sum game? Can everybody be winners, Brent?

BRENT THILL: Yeah. It's not a zero sum game. It's going to be Microsoft in the enterprise and Google and consumer. And Amazon will also be a beneficiary but more on the enterprise side with Microsoft. So two enterprise winners. I think one consumer, winner-- clear winner. Obviously, Meta, you have to bring into the conversation around AI as well.

Anyone that's used the Instagram service knows how good the matching engines are in terms of what you're interested in. So we see it is the companies in AI that will win are the companies that have the data and the users. And those are, again, Microsoft, Amazon, and enterprise in Meta, and Google in consumer. Those are the big four.

There'll be room for others. You know, Oracle can benefit on the enterprise but probably won't benefit as much. And so right now, we see Microsoft as probably the clear-- if you had to pick one, they are ahead of this. They started this whole AI arms race. They were the first ones to go at the beginning of the year, and they've obviously made the biggest investments.

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They've effectively now layered in a CapEx number that's now $12 billion higher. We were at $32 billion. Now, we're at $44 billion terms of CapEx. I mean, that is a lot of NVIDIA purchases. That's a lot of data centers. That's a lot of infrastructure they need to get ready for this AI rollout.

And again, I think it's going to be phased. It's not going to be overnight. We're not, all of a sudden, going to move into the AI house. It's going to be a slow, steady adoption pace, and it's not going to-- none of these products are really available yet until the end of the year in a big way.

So we're going to see this as a more of a 24 event than a 23 event. So again, the wave is coming. But the hype is, I think, a little maybe too strong. And you're seeing that with Microsoft stock down. Some investors felt like they would feel it more in the current numbers.

Again, you can't feel it when the products aren't shipping. So we remind investors, you got to wait for the products to launch. So Microsoft's done a great job of hyping it. So we got we got to get these products out in the market.

- With all that hype, is there any type of margin contribution that you look at as AI needing to generate a certain baseline of margin contribution in order for the valuations, in order for the hype that's been put forward by companies and their executives to make sense?

BRENT THILL: So AI, long term, will be very margin accretive. If you think about today, it's not. And what Microsoft got into is flat margins for next year, which is incredible considering all the investments they're putting into AI, when you think about, there's no revenue right now really from the products.

They have the marketing. They have the training. They have all the product development. They have the CapEx. They have everything. So basically, they've said that it's going to be the next half of their fiscal year that where the revenue starts. So the entire first half is really not a lot of revenue.

And to have flat margin tells you how margin accretive this can be. And then you think about year two, year three, year four in software, most of these customers, if you're an office user, you're paying $30, to $40, $50 a user, you're not paying $30 incremental for the copilot. So you're basically increasing prices by 50% to 100%.

That's incredibly margin accretive. It's not like Microsoft has to go out there and drum up a bunch of sales, like it's going to be self fed. They don't the cost of sales is going to be low because the ROI is so high. They'll have the inbound demand versus pushing this on people, like you're at a used car sales lot. That's not going to happen.

So we think over time, it's going to be margin accretive. And the fact that it's actually margin neutral with all these investments is actually pretty amazing to see, obviously, Microsoft's cutting expenses other places to fuel the way for AI investments. But this is, no doubt, a margin accretive over time.

- Brent, just to put a fine point on it, if people can't tell from how you're speaking about it, you've got a buy rating on the stock. You've got a $400 price target. So you think there's room to go up from here? And presumably, you would say that maybe today's drop is a buying opportunity. Given what you're saying, do you think Microsoft needs to do a better job itself of telling the story that you are telling? You said it's really been hyping up AI. Hasn't been doing it too much. Has it not managed expectations properly?

BRENT THILL: Yeah. I mean, it's a good question. I think, look, Mike, Nadella is CEO of Microsoft, they miss cloud. He got him back into cloud. He fixed their server business, their cloud business, their virtualization business. So they got back into the cloud game because of Nadella.

He is not number one in cloud. Amazon is in infrastructure. So if you think about-- ultimately what's happening right now is they had to put-- they had to-- they didn't want to lose this race in AI. And they're borderline going out in hyping-- I've never seen this before, where they've hyped it so far ahead of the launch.

So yeah. I mean, but they don't want to lose the war, and they want to own the narrative. And they're controlling the narrative. The callback with Microsoft last night, when I asked I, said, hey, maybe you're launching too many products. Maybe your customers are going to get confused.

There's too many AI models out there. And they said, we're in hurry up offense. As they get done, we're going to unleash them. So this is-- they're not going back to the huddle. They are literally on the line ready to roll. And they want to plow everything over in front of them.

In football analogies, they are ready to roll. And they are not going to hold back. And they do not want to lose to Google, or they do not want to lose to Amazon. Because they lost that cloud war to Amazon out of the gate. They're not going to lose this one.

- All right. Very much a Seahawks with Marchand Lynch days type of strategy that they're employing then, I suppose. Deeper into the football analogies. But I guess pulling back from those, let's talk a little bit more about Google or Alphabet here this morning too and their earnings.

A different strategy, perhaps. But at the same time, there's certain parts of the business where they're going to hope to leverage AI and lean into that. Where do you think it's going to be immediately evident that they're having success with their own artificial intelligence efforts?

BRENT THILL: Well, I think they're having it today. I mean, he pulled an LL Cool J don't call it a comeback. We've been in AI seven years. And again, I use the analogy for any consumer, jump in your car and go to work on Waze. It's not Judy or Joe telling you to turn left or right. It's the AI engine that's telling you where the traffic is. Right.

Turn on YouTube TV. And in the morning, it'll tell you, are you interested in your local news, or ESPN, or some other show? Right. It surfaces the content you want right in YouTube TV as you turn it on. When you do a search and look for a restaurant or look for-- this is infused with AI already today.

And I think this is the point, which is it's infused today. And if you look at their spend, Microsoft had to take their CapEx from $32 billion to $44 billion. Google didn't really bring their CapEx up in a material amount because they've already been investing. And so what I've said is there's so much technology inside Google that we can't see they're going to unveil. And I think we're all going to be blown away.

As some of the top computer scientists that we've interviewed that teach at Stanford, and have been part of Apple, and other major tech corporations, they're like, this is crazy that "Wall Street" doesn't think they have good AI. They have better AI, and they've contributed more to AI than anyone.

So we have a situation, where "Wall Street's" like, Microsoft's going to crush them in AI. Their demo blew up, short Google. That's wrong. And that's why Google stocks going higher because investors are underweight Google because they think they're going to get run over an AI, which is not true. This is not a zero sum game. They're both going to win.

And Alphabet is underappreciated for AI. And I think, again, they mentioned it 52 times in their prepared remarks. 52 times. And that wasn't even in the Q&A. OK, it was more than Microsoft. And that tells you that they're upset.

And they're not saying this. But I got a sense, they're not happy with how "Wall Street's" treating this or "Main Street's" treating this. And they're going to be clear what they have. And I think we're all going to be shocked. Stocks going higher.

- Yeah. I picked up on that a little bit at the end of the call when Philipp Schindler was asked a couple of questions about how they're incorporating AI into tools for advertisers. And he said, well, I did talk about that earlier on the call and gave sort of details about how it's being incorporated.

Brent, I do want to ask you another question that's very important about Alphabet, and it has to do with Ruth Porat. Obviously, she's getting this big new role. Are they setting her up to be CEO eventually?

BRENT THILL: Absolutely could be. And I think that she did a fantastic job on the buyback. She brought the buyback to Google. They've been leaning in. They've been buying the stock back. I think investors have been disappointed with their investor friendliness.

If you think about Microsoft giving guidance, and more color, and doing calls, and being really transparent, and bringing people on campus, I mean Microsoft has done a phenomenal job. And I think that investors want more. Institutional investors want more out of Google.

So I'm hopeful the new CFO that comes in can give a little more color and analysis. We maybe get that. I think operationally, she did a phenomenal job. And well deserved and super happy for her. So yeah, I think it seems like from an operational perspective, it sets her up for better things ahead.

- Brent, while we have you, let's pivot to one other company that did report earnings and has seen investors react, but quite negatively here, especially after the earnings dropped. Snap ultimately just some disappointment from the Street that is evident in the stock price reaction as it move lower by about 17%. Still lower here this morning by about 18% here. I just want to get your general take on what the company had to say and if this is a company that's still is worth? Investors kind of holding or kicking the tires on at all.

BRENT THILL: We don't have a buy on it. As our team has covered this, I think it was the disappointment in the operating expenses obviously coming in the losses that they're seeing. And I think ultimately, I've said this repeatedly, when we pull teenagers and younger audiences, most of them are using Snap because I don't want their parents to see their instant messages. They use the messaging platform.

But they're not influenced by the content on Snap. They don't see an ad and then convert. They don't have the money. The parents have the money, right. And so ultimately, I think this has been a younger audience tool. It's been a communication tool.

But they're not able to monetize the users the way that they should. So there's an incredible viral adoption of the younger audience that loves this. They can see where their friends are on the map. They can message. They haven't monetized it. So this is an opportunity where you have the users, but you don't have the money. And ultimately, they need to fix that. And again, I think this is a long road back.

- And I'm curious where it ends, Brent. Two final questions on Snap. Five years from now, one does it exist as an independent company, two, does it exist at all.

BRENT THILL: I think right now, there's a lot of questions. I mean, TikTok and Meta with Threads is really taken over. Threads and reels. And so I think when you start to think about the-- there's been some share that's been stealed away from them.

So do they need a partner? Do they need to be acquired is there some other roadmap that they need to go playbook, they need to go down? I think they're clearly showing that that's the case. I mean, there's financial stress here. So when you have financial stress and you're not benefiting relative to others, you've got to look at alternatives. I don't know the exact alternative, whether it's a partnership and acquisition. But they've got to do something different because it's not working.

- Brent Thill, Jefferies' senior analyst. Thanks so much for joining us this morning, and we're going to let you go before that sun rising in the East starts to hit your eye. We want you to be safe over there.

BRENT THILL: Thank you.

- Thanks so much, Brent.