ChatGPT Valued At $29 Billion – Microsoft Has Exposure

Summary:

• Recently, OpenAI announced that it would be selling partial ownership in itself, $29 billion valuation.
• The round would see ChatGPT’s value double in two years.
• There are no ways to directly get in on the deal, but you can get indirect exposure.
• In this article, I will explore how you can get exposure to OpenAI and ChatGPT via Microsoft stock.

ChatGPT is the topic that’s got everyone talking these days. An AI chat bot, it has been used to create everything from content to computer programs to advertising copy. Among investors, ChatGPT has caused a stir because of its potential to compete with Google (GOOG). Elsewhere, it has led to worry about certain professions becoming obsolete.

In the venture capital world, ChatGPT has created buzz for another reason:

The $29 billion valuation the company may soon get. According to the Wall Street Journal, OpenAI is in talks to sell a $300 million stake in itself, which values the whole enterprise at $29 billion. That’s a little more than double what the company was worth last year.

It’s remarkable that a tech company is seeing such rising valuations right now. The NASDAQ is down about 33% from its November 2021 peak, and barely anybody is going public in this environment, because it doesn’t look like an environment in which valuations would be high. In fact, those who think that this isn’t a good environment to raise capital in are probably correct: ChatGPT is simply a huge outlier.

Which goes to show what a huge splash the app has made. It reached 1 million users in just a week, which is faster than Facebook and TikTok did. Many people think that ChatGPT could ‘disrupt’ Google Search, which is also used to retrieve information, and the app already has wreaked havoc in classrooms across the world.

Which raises the question:

How do you get exposure to this deal?

The companies about to invest in ChatGPT are not publicly traded. Most are funds that you need accredited investor status and large sums of money to invest in. However, there is one company that lets you get indirect exposure to ChatGPT:

Microsoft (NASDAQ:MSFT).

Microsoft invested $1 billion in OpenAI back in 2019. I wasn’t able to find concrete information on the implied valuation of the Microsoft deal, but it was two years before the $14 billion deal. It looks like Microsoft is sitting on significant on-paper gains. Additionally, Microsoft was able to pay for the deal with a combination of Azure credits and cash, so the actual cash outflows to make the investment were smaller than they appeared. Additionally, Microsoft stock has fallen over the last 12 months, while the following performance metrics increased:

• Revenue (up 15.2%).

• Operating income (up 13%).

• Operating cash flow (up 7%).

• The value of the OpenAI investment (up more than 100% assuming that Microsoft paid less than the people who bought at the $14 billion valuation in 2020).

So we’ve got Microsoft’s stock going down, while its key performance metrics and possibly also the value of its OpenAI investment are going up. The overall package certainly looks attractive. Indeed, I found it attractive back in 2020, but I sold it in late 2021 in anticipation of the tech stock crash that was to come. My MSFT sale was well timed, but today, I consider the stock to be once again a pretty good buy.

However, that leaves open the question:

Is it worth buying JUST for the ChatGPT exposure?

Microsoft is a huge business with many moving parts. It has $95 billion in tangible book value. The $1 billion OpenAI stake is 1.05% of that, or 2.18% if we assume that Microsoft got in at or lower than the $14 billion 2020 valuation. It seems likely that Microsoft got in at a valuation lower than today’s, because ChatGPT (the catalyst that’s driving this huge funding round) didn’t exist in 2019, when Microsoft bought it. For the sake of being conservative, I’ll assume that OpenAI represents somewhere between $1 billion to $2.07 billion in value to Microsoft.

It looks like Microsoft’s OpenAI position is growing in value. However, it’s hard to say exactly how much of the growth is justified. OpenAI has never released a public financial statement. We know that its user growth is the fastest in the history of any tech service. Assuming that the company’s paid plans are being adopted as quickly as ChatGPT’s free interface is, then that would imply the revenue growth is off the charts. One thing we do know is OpenAI’s revenue guidance: it expects to hit $1 billion in revenue by 2024. That leaves Microsoft’s investment at a deal price/sales ratio of 1. In principle, that is a positive, but we know pretty much nothing about OpenAI’s profitability, or plans to achieve profitability should it not be profitable currently. Obviously this is the kind of deal that gets venture capital investors salivating, but from the perspective of a Graham/Dodd value investor, there just isn’t enough information here to appraise the asset.

Microsoft: Valuation Without ChatGPT

Because there is so little financial information available about OpenAI, we can’t assess how much Microsoft’s OpenAI position is worth, so we need to look at what the company is worth overall. Microsoft offers ChatGPT exposure, but it’s not reasonable to buy the stock just for that exposure. There are two reasons for this. First, OpenAI is fairly small as a percentage of all of Microsoft’s assets. Second, we don’t know what its net effect on Microsoft’s results will be.

What we do know is Microsoft’s recent performance. In its most recent quarter, it delivered:

• $50.1 billion in revenue, up 11%.

• $21.5 billion in operating income.

• $17.6 billion in net income (down 14%).

• $2.35 in diluted eps (down 13%).

It was a mixed showing. Top line growth was strong–in particular compared to competitors–but net income declined. For comparison, Apple (AAPL) had positive bottom line growth in the same period.

Now let’s look at the long term averages courtesy of Seeking Alpha Quant. According to Quant, Microsoft has compounded the metrics listed above at the following five year CAGR rates.

• Revenue: 15%.

• Operating income/EBIT: 15%.

• Net income: 22%.

• Diluted EPS: 22.5%.

It’s been a pretty strong showing on the whole. Microsoft has grown a lot over the last five years, driven by the popularity of its Azure Cloud Service. Azure is the second biggest cloud service after Amazon (AMZN) web services, and one of the fastest-growing. We can’t just project past growth into the future, but the fact that OpenAI was willing to accept Azure credits in lieu of cash for the deal with Microsoft is a good sign. It suggests that, as OpenAI scales, Azure will scale with it.

Finally, we have the valuation multiples. At today’s prices, Microsoft trades at:

• 24 times earnings.

• 8.3 times sales.

• 10 times book value.

• 19 times operating cash flow.

These multiples are frankly a little steep. Even by the standards of tech stocks, which are usually pricey, the book value multiple is very high. Microsoft has some growth to back this up, but there is no guarantee that the high growth will continue into the future. If you have a very long time horizon, you might benefit from buying MSFT now, but personally I’d wait for a cheaper price.

The Bottom Line

The bottom line on Microsoft is that it’s a great company that was an early investor in one of the biggest things to come out of the tech space since Airbnb (ABNB). Not only does Microsoft have a financial interest in ChatGPT, it’s also working to integrate ChatGPT into Bing, integrate DALL-E designs into Designer, and so much more. The potential here is significant. I avoided mentioning the ChatGPT/Bing integration for most of this article, because personally I think that story is a bit overrated. Google has its own advanced AI: I doubt some ChatGPT responses alongside organic search results will suddenly make Bing relevant. On the other hand, the Dall-E designs are really promising. Google’s office suite currently includes basically every office tool you’d want except a good drawing app. If Microsoft executes well on Designer then the addition of Dall-E art could only be a positive.

Still, the pesky matter of valuation lingers in my head. Microsoft was about $200 when I bought it in 2020, I sold it for $300. I’d want to see $200 before buying it again. True, Microsoft was doing way less earnings back when I bought the stock for $200, but interest rates were lower then, too. This macro environment hasn’t been kind to growth, even moderate-growth tech like MSFT.

Looking at all of the relevant factors, we can see that Microsoft is a great company. It has a growing Cloud business, it’s big in gaming, and it’s one of the earliest investors in the AI app that’s rapidly transforming the tech world. None of these factors guarantee that MSFT will perform well in the stock market. However, it’s enough to prove that the stock is a buy at some price. If your time horizon is long, today’s price is a perfectly fine entry point. Personally, I’d wait for $200 or lower.

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Disclosure: I/we have a beneficial long position in the shares of GOOG, AAPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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