Microsoft: Cyclical Negatives Obscuring Secular And Technology Positives

Summary:

• Microsoft’s latest quarter showed the effects of cyclical headwinds of various kinds on the company’s business.
• Growth guidance for the company’s Azure business disappointed.
• Earnings and cash flow estimates were cut.
• Yet none of this represented a deterioration in the company’s market position or loss of share in any relevant market.
• The company’s various strategies to grow faster than the market and to improve margins are battling macro headwinds but remain successful.

Microsoft’s latest quarter: Warts on display; Opportunities on the horizon

I don’t usually write about specific quarterly results for different companies. I realize that many readers are anxious to see an evaluation of quarterly results in the shortest possible time. I used to do that as part of my job as a brokerage analyst; for the most part, providing a horseback evaluation for clients was not the most productive use of my time-or so far as it goes, theirs either. While quarterly results and the following conference calls are the best insight most investors will have into the current state of demand for a company’s services and the issues and opportunities of its business model, at the end of the day, they are just quarterly results. By the time you read this, 45 brokerage analysts will have published 45 reports on Microsoft (NASDAQ:MSFT) trying to evaluate the company in the context of its guidance and to a lesser extent, its quarterly numbers. There will also doubtless be many SA articles, and articles from other market commentators on the same point. There will be a couple of ratings changes-and they will be downgrades, 45 estimate changes, all down, probably 45 price target changes, all of them reductions. By the time you read this, all of those changes in both numbers and dialogue will be incorporated into the share price, I believe.

I am not going to try to persuade anyone that black is white. The quarter that Microsoft reported was mediocre to put the best spin on it, and the guidance certainly has shaken some shareholders and analysts, although the shares wound up the day after earnings with just a marginal loss. This is not an article that suggests a trading strategy for Microsoft shares or their likely relative performance over the next few weeks or even months. A large part of the trend of Microsoft’s share price in the short term is going to be a function of market sentiment toward risk-on trades that rely on future growth for their justification. And in turn, that sentiment will mostly be a function of investor beliefs about recessions, soft or medium or hard landings, inflation and the cadence of a Fed pivot. This is NOT intended to be an article about any of those subjects. Trying to forecast the “hardness: of the landing is not something that I think I can do; frankly, given the recent track record of professional economists, I am not so sure that such a forecast is possible given the technologies that currently undergird how economists make projections.

Should readers buy or hold Microsoft shares. One SA contributor has rated the shares a sell in the wake of the recently released earnings. I own the shares, have done for several years, and expect I will continue to do so. But I acknowledge that owning the shares is not necessarily part of a strategy of maximizing short-term percentage returns. As I will explore in this article, Microsoft is dealing with both the cyclical slowdown in cloud consumption, a slowdown in growth of its most popular applications, and a unique cyclical slowdown in Windows OEM which has impacted margins and cashflow.

The Morgan Stanley analyst team recently opined that “messy prints look increasingly priced in.” That is basically my conclusion when it comes to Microsoft shares and the recently reported quarter. No, the quarter wasn’t pretty to consider, but anyone who has owned the shares, or even those just considering the establishment of a position, ought to have been well aware of the shoals that have made the recent Microsoft investment journey more than a bit choppy. Microsoft’s valuation has long been supported by its lofty free cash flow margin has been in the mid 30% range. The free cashflow margin fell to about 10% last quarter, down from about 17% in the year earlier period-there is significant seasonality in free cash flow margin with free cash flow margins reaching a peak in the company’s fiscal Q4.

Microsoft has a broad range of businesses, some of them more cyclically sensitive than others. It is worthy of comment, that Windows OEM revenues fell by 39% last quarter, and in turn this caused revenues in the More Personal Computing segment to fall by 19% year on year, although because of seasonal factors the segment’s revenues rose sequentially. More Personal Computing represented about 27% of Microsoft’s revenues last quarter, and about 16% of the company’s operating income. Segment operating income declined more than 45% this past quarter. This was hardly surprising to anyone who has followed or invested in Microsoft shares for a significant period-after all this is what was forecast by the company CFO the prior quarter and for that matter even in earlier conference calls.

Should Microsoft’s result’s and guidance shake readers? The broadly consensus view is that until the company can demonstrate that Azure growth is no longer declining, the shares will be range bound. I don’t think I need to quarrel with that view so far as it applies to the next few weeks or even the next quarter, although I will observe that stocks often anticipate actual turns in operational performance. I don’t expect that anyone buying IT shares Wednesday afternoon in the wake of the Fed Chairman’s press conference was doing so because they expected the earnings of IT companies to accelerate significantly in the next 1-2 quarters. Looking at Microsoft, specifically, Is the guidance now sufficiently de-risked? There is some thought that the company chose to be more conservative than usual in providing a forecast, and its forecasts are almost invariably conservative.

Just to answer the question above, there was nothing in these results that was much of a surprise, or which should shake the convictions of long term investors about the company’s future. To be quite specific, the Azure revenue model is based on usage. For some quarters now management has been telegraphing that its users were “optimizing” their usage of Azure and this was leading to constrained revenue growth. The CEO, specifically, said that the savings users were achieving through optimization were going into new workloads for its cloud. And based on what he actually said, rather than the construction some have chosen to put on his comments, these new workloads should begin to buoy revenue growth going forward-actually within the next 2-3 quarters as the year cited in the quote below is the fiscal year that ends 6/30/23.

Kash Rangan

Thank you very much. Satya, I am curious if you could talk about how long the cycle time for optimization lasts. Are we talking a couple of quarters, few quarters or multiple years, because I do take your comment about tech spending as a percentage of global GDP going higher? So, if that were to happen, this – how do you frame the duration of this optimization that’s happening in the industry? Thank you so much.

Satya Nadella

I mean I think that you can – you have a workload, you optimize the workload and you start a new workload. So, the thing that I would say is when you are done with optimizing a workload is when you are done with the cycle. So, I think if you sort of say, when did we enter this, we accelerated existing [ph] workloads during the pandemic over a period of 2 years. So, we are optimizing. I don’t think we are going to take 2 years to optimize, but we are going to take this year to optimize. And then as we optimize the new projects start and the new project starts don’t start instantly at their peak usage. They start and then they scale. And so those are the two cycles that will happen where there will be a time lag.

Honestly, this is not really a new concept, it is an old concept played out in a new context. IT spending has always had a very high demand elasticity. Optimizing is not a code word, as one commentator suggested, for flagging demand. It is the strategy of reducing the cost of a unit of compute in a workload. In turn, that leads to stronger demand for new workloads, and starts the growth cycle again.

I will also observe that these results and this guidance are in the context of macro headwinds and as such has been anticipated by most Microsoft investors and commentators for some quarters now. Microsoft exists in the economy; its results are not going to show positive trends when economic activity is contracting. Even more specifically, as mentioned, Azure, which is the flash point of negative reviews, is a usage based service. Azure annual bills can easily top $100 million for larger users. When companies look to control their expenses, payments to opex vendors that exceed $100 million/ year are going to be carefully scrutinized.

Microsoft is being impacted by macro headwinds. And macro headwinds are going to persist for a couple of quarters, perhaps until the Fed pivots, or perhaps until the value or the necessity of the using cloud applications to run enterprise business becomes more evident to Microsoft customers. While Microsoft’s results are going to be impacted by macro headwinds, the question that arises is whether its long-term expectations have changed, and whether its valuation will be more impacted by a Fed pivot than by the short term operational issues that were outlined during the earnings presentation. The company’s opportunities, of which there are many, are not being upended or even greatly deferred by quarters that reflect macro headwinds. At least to me, the investment that Microsoft is making into OpenAI, and the solutions that will come from that investment, are of far more importance than the confirmation that Azure’s usage based revenues can be impacted by macro headwinds.

I have been a long time investor in shares of Microsoft shares; I initially established a position in 2017 and have added to it opportunistically and have written about its investment merits on SA from time to time – 24 times the record says. So, perhaps that inflects my comments to some extent. I will review the reasons why I think the company’s overall strategy has been successful, and how infusing its stack with OpenAI technology will build on that success. Migrating applications to the cloud is not going on hiatus, and the factors that have led Azure’s market share gains haven’t changed either. The cloud barely existed as a major factor in IT demand when there was last a recession. The fact that its usage, as opposed to adoption, has some cyclical sensitivity is not a huge surprise, or something that ought to lead to investor consternation. The ability the company has had to sustain margins despite the substantial headwind created by the cyclical decline of More Personal Computing revenue should be quite heartening to long term investors.

The decline in Azure Growth-Worrisome or just cyclical headwinds?

The growth of Azure revenues has been the basic reason why many investors have made a significant commitment to Microsoft shares. Microsoft doesn’t specifically report Azure revenues and their actual level has been a source of controversy. At this point, the preponderance of the evidence suggests that Azure revenues on a standalone basis have reached to the low $40 billion level on an annualized run rate basis, or around 20% of the company’s revenue. There has been and remains some uncertainty with regards to the exact level of Azure revenues; some months ago, competitor Google (GOOG) (GOOGL), apparently working with purloined documents, said that Azure’s revenue were lower than the then mid-point of analyst guesses. Some of that report has subsequently been discredited.

Regardless of the precise revenue number, and even the precise margin contribution (Google has suggested that Azure operating margin is negative because of aggressive pricing; that is supposed to explain its above market rate growth-and by inference the inability of Google to match Microsoft’s growth in this market.), it is obvious, I believe, that Azure has been gaining share in the public cloud IaaS space and has been doing so for some time now.

There are reasons for that. I won’t even try to suggest that Azure is a “better” service in terms of key performance metrics, or it is cheaper for users. There are all kinds of claims in this space, and third party analysis certainly doesn’t suggest a clear choice as to whose solution is best, and for whom-although the link above, suggests Azure is the best of the bunch. The waters are even more muddied when it comes to considering the cost of ownership. It is really a function of workloads, and the specific mix of services that users elect to purchase. Nor, I believe, is Microsoft’s success a product of a more or less effective sales motion than its competitors. Anecdotal evidence that I have suggests that none of the large public cloud companies excel in sales execution and this last quarter, for what it is worth, the CEO of Microsoft called out sales execution as a problem rather than a positive differentiator.

My view is that Microsoft’s success with Azure is basically because of its platform approach. For example, Teams, is a wildly popular application. Teams is optimized to work with Azure and some users will consider buying Azure simply because the performance of Teams is so important for their operations.

Probably the most important integration offered by Microsoft is that of Dynamics365 with Azure. The success of Dynamics365 in terms of its own market share gains has been substantial. Dynamics365 is optimized to work with Azure.

It would be foolish to even try to suggest that Teams is better or worse than what is being offered by Slack/Salesforce (CRM) or that Dynamics 365 is a better offering than the Oracle (ORCL) Cloud ERP or SAP’s (SAP) cloud offerings. There has been and will be much written about vendor consolidation. Microsoft Azure is perhaps the service that has derived the greatest benefit from that trend. It is obvious, I think, that the Microsoft stack offers users a far more comprehensive set of solutions, that the offerings of either GCP or AWS (AMZN).

And while Azure may or may not have a more attractive pricing structure when compared to GCP and AWS in isolation, many users are going to achieve an overall lower cost of ownership when using a Microsoft centric stack. I don’t want to suggest that the stack approach is some kind of universal panacea. That isn’t the case and some users prioritize the avoidance of vendor lock-in as opposed to vendor consolidation. But I think the stronger growth of Azure has been mainly a function of its being part of a comprehensive stack, while the offerings of its rivals simply have no such exogenous demand driver. There is every reason to believe that Azure’s above market growth will continue, and that is certainly true in the wake of the company’s announcement with regards to its investment in and collaboration with OpenAI.

The other question some may ask is what is the outlook for the growth of the public cloud? As mentioned, the public cloud barely existed at the time of the last recession so there is no real guide as to how users will moderate their growth in usage. The market size for the public cloud, overall is projected to be about $525 billion this year as suggested by the link here. Of that amount about half is from apps, and the other half is from the infrastructure, the market addressed by Azure. That said, the study doesn’t really break down the infrastructure space, and thus overestimates the TAM actually addressed by Azure. The CAGR through 2027 is forecast to be 14%.

But what about this year, 2023? Gartner in the link presented here, forecasts growth in the space will be about 21% this year. Infrastructure, the part of this survey in which Azure competes, is expected to rise by 29% this year to $150 billion. So, that suggests that Azure has a market share of a bit less than 25% and is still growing faster than the overall market.

The study does show that growth of cloud based applications, as opposed to infrastructure, is experiencing some impact from macro headwinds. Given the near unanimity of IT company managements suggesting that their sales cycles are elongating, and deals are being postponed and are being broken into smaller agreements, this is not terribly surprising. This has happened to Microsoft; it sells public cloud infrastructure and cloud applications and the growth of the offerings has slowed, but is still at rates indicating market share gains.

There are some commentators who have made the assumption that the current growth slowdown in the growth of cloud usage relates to something more than a cyclical headwind. The migration to the cloud is not a matter of style, but one of substance. Simply put, running applications in the cloud has significant advantages in terms of cost, performance, time to deployment (efficiency of cloud native development) and security. While the growth in usage of cloud infrastructure is self-evidently slowing, the migration of apps to the cloud is continuing and seems likely to continue. Users may be looking to optimize cloud usage; on the other hand, any user looking to optimize overall IT spend will seek to move as many workloads to the cloud as possible-the savings in opex by doing so is just that substantial. Usage growth seems partially correlated with economic activity; while it can be difficult to forecast, its decline is likely to be more in the nature of a speed bump than a trend.

The rest of Microsoft

This is not meant to be a comprehensive analysis of all of the company’s many different businesses. I have tried to touch on the highlights that can move the needle. While Azure has been the growth driver for Microsoft for some time now, 80% of the company’s revenue comes from other sources. The company reports specific revenues and operating margins in 3 discrete categories which are productivity and business processes, intelligent could, and more personal computing. It also reports the growth of many other segments in terms of percentages. At this point, the Intelligent Cloud segment, which is the largest segment with almost 42% of total revenue, is also the fastest growing, despite the growth rate declines of the past 2 quarters. It is also the most profitable segment, accounting for almost 44% of net operating income.

Microsoft is now enduring the return of its Windows OEM business to the business levels seen before the spike caused by the pandemic and its aftermath. And it is also dealing with declines in gaming revenue with Xbox revenues falling by 10% overall and also with a very noticeable decline in revenues from its Surface PC business. While the More Personal Computing segment saw revenues decline by 18% year on year, operating income in the segment fell by 47%, or $2.9 billion. The company is forecasting a slightly slower rate of decline in this current quarter with no significant improvement in any of the negative trends the company has reported.

Windows OEM is not likely to return to growth any time soon. What is more likely is that the precipitous fall in revenues will abate simply because comparisons lap and no longer will reflect the growth in PC shipments during and shortly after the pandemic In turn. that will stabilize the revenue performance of the More Personal Computing segment. With more stable revenues and the recently announced layoff, the segment operating profit ought to stop falling; I think it can even start to grow by the end of the year based on cost containment measures. It is one reason why I anticipate that the company’s EPS growth can exceed consensus levels by the end of the current fiscal year.

One of Microsoft’s major businesses is Dynamics, the company’s application software brand. Microsoft now gets 80% of its Dynamics revenue from its cloud offering. That is one of the key factors in its ability to continue to grow app revenue at greater than market rates-it simply doesn’t have the boat anchor of on-premise application revenues of its rivals. In addition, some of the sales execution issues currently plaguing Salesforce, have enabled the company to pick up some share points as well. At this point I think most industry analysts consider Dynamics 365 and its competitors to have rough functional equivalence. But the fact that Dynamics 365 is optimized for Azure, and vice versa is a significant strategic advantage. The application software business, even its cloud component, is not terribly exciting. But market share gains and improving segment margins in this category can be exciting for investors.

The other business segment on which I focus has been Office Commercial 365. In constant currency, Office Commercial 365 grew by 18% last quarter, despite the issue of macro headwinds. Seats are still growing and ARPU is still rising. This is the segment that includes Teams as well as the traditional apps associated with Microsoft such as Outlook, Word, Excel and PowerPoint. Microsoft has managed to keep in front of the curve here by adding features that seemingly resonate with users. Some of the growth in this segment has been inorganic as the result of the company’s acquisition of Nuance, but other than that growth has remained fairly stable, and the company is forecasting that to continue despite macro headwinds. The Nuance speech recognition solution is based on AI technology and will likely benefit from the technology available through the OpenAI partnership.

There are of course many other segments of some significance in assessing Microsoft’s growth rate, both currently and in the future. LinkedIn has seen some contraction of growth as part of the overall pullback in digital advertising as well as lower hiring. Overall, the company has a variety of solutions that address the digital advertising market, and like much else in the digital advertising space, it is facing macro headwinds (although perhaps Meta’s results reported Wednesday afternoon suggest that the demise of the digital advertising space has been…exaggerated.) At this point, the headwind posed by the decline in digital advertising spend is not really material, and it isn’t likely to be all that material when the tide starts to reverse.

The company has an extensive security portfolio; it is one of the leaders in endpoint security, and it offers Defender for the Cloud as well as Sentinel, a SIEM offering. If its cybersecurity offerings were an independent company, it would be the world’s largest-but of course if it were an independent company, it could never have grown to the extent that it has. The advantage of Microsoft security is not specifically functionality; it is that a Microsoft solution is available at a lower price than what is available from point providers, and it is available on a single platform. As mentioned earlier, platforms provide significant sales synergies, and Microsoft is reaping those benefits. Overall, security revenues were indicated to be around 10% of the company’s total, and the company maintains that it is taking share. While given the nature of the security space it can be difficult to precisely measure market share, security is a component of the Microsoft offering growing more rapidly than the company as a whole, and this should persist into the foreseeable future.

Lots of commentators want to comment on Microsoft’s proposed acquisition of Activision (ATVI). I simply lack the second sight necessary to make an informed judgment as to how this plays out. The field of antitrust is one in which there are a multiplicity of opinions. I personally do not see this merger as anti-competitive or that it violates any of the relevant anti-trust laws in this country or that is breaks with precedent. The current administration has different views and so, apparently, does the competition authority in the EU. I think it is best to analyze the company as it is…and if a deal is eventually reached to buy some or all of AVI on a reasonable basis that would be lagniappe.

OpenAI/ChatGPT-Hype, game changer or something in between?

Yes, AI is overhyped. It has been overhyped for some years since IBM’s (IBM) Watson was going to change that company, or when Einstein was supposed to have a similar impact on the growth of Salesforce. On the other hand, somewhat stealthily, AI has come to suffuse a vast preponderance of new applications as they are developed.

As I think most readers are aware, Microsoft has made a significant investment (probably $10 billion) into a company called OpenAI. OpenAI was founded at the end of 2015 and is organized as a non-profit research company, and a for-profit limited partnership. Initially, the company was funded by some high profile investors including Elon Musk and Peter Thiel. The company adopted its structure in 2019 so it could be competitive for talent. It is a rather complicated structure with some ostensibly conflicting roles for investors, employees and directors. In any event, Microsoft began investing in the company and was one of two investors who put $1 billion into the company at that point.

Since that time the company has introduced GPT-3, a natural language for asking and answering questions. GPT-3 is the heart of the company’s product strategy. In 2023 the company introduced DALL-E, a deep learning model that can produce digital images when an object is described orally. The product that has received the greatest attention is ChatGPT based on GPT-3. While Chat’s ability to write term papers and play games has gotten most attention, in fact it can be used to write and debug computer programs. The models were trained in collaboration with Microsoft, using the company’s Azure infrastructure.

Microsoft has developed a service based on that technology available as part of Azure. Azure is OpenAI’s exclusive cloud provider and Microsoft will be deploying the models that have been created across the company’s various products. While Azure Machine Learning revenues have been growing at triple digit rates according to the company CEO, the company hasn’t disclosed what that means in absolute dollars. Obviously it is nowhere near enough to overcome the contraction in usage growth.

The use of ChatGPT to write term papers and articles, to compose music and poetry and to simulate an entire chat room has gotten lots of attention. The technology has some serious limitations; the one called hallucination is most prominent which can cause the bot to write incorrect or nonsensical answers. It is still in shakedown mode; it doesn’t recognize events that have occurred since 2021 and it is going to have issues-as it really should-in dealing with political opinions.

I really am quite unable to answer the question as to how Chat’s technology compares to what is on offer by Google or by C3.ai (AI) and others and how its development path might look over time. My guess is that ChatGPT does have a significant lead in terms of the functionality of its models, but the overall opportunity is of a magnitude that there certainly will be more than a single winner. Google is said to be ramping its AI investment and investors, and users will be faced with a plethora of competing claims about which model is more accurate, and which service provides the best business value. I have no way of attempting to handicap the race other than the obvious comment that ChatGPT is an early leader. Microsoft’s CEO, of course, has been very positive in his evaluation of the development.

Now on to AI. The age of AI is upon us and Microsoft is powering it. We are witnessing non-linear improvements in capability of foundation models, which we are making available as platforms. And as customers select their cloud providers and invest in new workloads, we are well positioned to capture that opportunity as a leader in AI. We have the most powerful AI supercomputing infrastructure in the cloud. It’s being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT.

Just last week, we made our Azure OpenAI service broadly available and already over 200 customers from KPMG to Al Jazeera are using it. We will soon add support for ChatGPT, enabling customers to use it in their own applications for the first time. And yesterday, we announced the completion of the next phase of our agreement with OpenAI. We are pleased to be their exclusive cloud provider and we will deploy their models across our consumer and enterprise products as we continue to push the state-of-the-art in AI. All of this innovation is driving growth across our Azure AI services. Azure ML revenue alone has increased more than 100% for five quarters in a row with companies like AXA, FedEx and H&R Block choosing the service to deploy, manage and govern their models.

Daniel Ives of Wedbush said that the collaboration between Microsoft and OpenAI had the potential to be a game-changer. That is probably hyperbole. I do think the AI paradigm can add about 200-300 bps to Microsoft’s CAGR over time. That means that it is reasonable to anticipate the company will be able to achieve mid-teens revenue growth at margins that are comparable to the corporate average. The various AI services now available and to be available as part of Azure seem to have the potential to step up the usage of Azure, and it will probably help Azure to continue to grow at greater than market rates. Microsoft’s Bing search engine is apparently set to incorporate OpenAI technology in the next several weeks, perhaps leading to a spike in Bing usage and thus Bing advertising revenues. Eventually, I expect to see AI being used in many of Microsoft’s applications and it may provide it with competitive advantages in areas such as Dynamics365 and all of the many aspects of Office 365. I certainly wouldn’t base a share purchase recommendation solely on the tailwind that the OpenAI collaboration is likely to provide to Microsoft’s CAGR. But equally, it is quite a bit more than a non-event as some have suggested.

Wrapping Up: Microsoft’s Valuation and reviewing the investment case

Microsoft reported a rather mediocre quarter a week ago. The shares, after initially falling are now trading a bit above where they were before the earnings release, helped in part by a decent market environment for IT equities.

Microsoft has a relatively elevated EV/S ratio for its current growth rate-I have estimated its 3 year CAGR will be around 13% and my estimate of its EV/S ratio is 7.6X. Its relative valuation is much more reasonable when considering the combination of its free cash flow margin and its growth rate. While its free cashflow margin is compressing this year as it deals with the major cyclical downturn in its Windows OEM business, the rest of its business is continuing to enjoy strong margins despite constrained growth. I am estimating that the company’s free cash flow margin will bounce back to 31% from its current level over the next 12 months.

Microsoft is having to deal with the same ills that almost all IT companies are facing; i.e. a noticeable moderation in demand growth. This has become most noticeable in the growth of Azure where usage growth has slowed noticeably although it is still projected to be in the low 30% range. But almost all segments of the company’s business are seeing slowing demand growth. Specifically for Microsoft, its results are burdened as well by significant cyclical pullback in Windows OEM revenues as PC demand reverts to pre pandemic trends. In turn, the sharp fall in demand for Windows OEM has severely impacted the margins in the More Personal Computing segment and has also led to a drop in the free cash flow margin.

None of this was really unanticipated. I believe that most of the current revenue growth issues have already been priced into the valuation of the shares. Usage levels for Azure will probably see a nadir in the next couple of quarters although to some extent, usage can be a function of how enterprises respond to challenging economic conditions. Migration to the cloud-and that means Azure-will continue despite the uncertain economy. Growth of the other segments of the company will probably start to see a recovery later in the current calendar year, somewhat due to the lapping of difficult comparisons. The company will lap the comparisons that have caused its Windows OEM revenues to crater. In addition, the company’s announced layoffs, painful as they are, will start to positively impact margins and free cash flow as well over the next 2 quarters.

I believe that Microsoft’s platform strategy has done much to enable its various offerings to grow their market share. And I think that the strategy will continue to be a substantial tailwind for demand for the foreseeable future. The ability of Azure to grow at above market rates is a function of this strategy and the ability of the company’s application suite, Dynamics 365 to take share is part of this same paradigm.

Trying to quantify the exact parameters of Microsoft’s collaboration with OpenAI is more of a guess than a forecast at this point. OpenAI’s ChatGPT is winning lots of attention these days, and that functionality is getting built into many Microsoft services including Azure and Bing. For now, investors should consider the collaboration, and the associated products as more in the way of lagniappe than a core part of the company’s business. But saying that, I expect that Microsoft will achieve a lead in the deployment of useful AI technology, and in turn this will lead to additional market share gains across the Microsoft stack and to a noticeable acceleration in the company’s CAGR. I don’t believe such acceleration is priced in since it is not really feasible to quantify at this point.

Buying Microsoft shares currently means having to look through another couple of messy quarters. Investors seem more disposed to do that kind of looking these days than in the recent past. Some analysts have advised investors to wait for some demonstrated bottom in usage before committing to new positions in the shares. In my own experience, if investors wait until the demand headwinds have abated, and such abatement is broadly visible, the opportunity to buy the shares at a reasonable valuation will be lost.

Microsoft shares will not tick the boxes for all growth investors. I don’t expect this to be the leading recovery candidate if a risk-on bias persists in 2023. I tend to regard the position in Microsoft shares in my own portfolio as ballast in what is mainly a highly risk-on set of commitments. Thus, in a balanced IT portfolio Microsoft shares are well placed, and that is why I have owned them and will continue to do so. And if the company’s AI initiative takes flight and produces substantive revenue gains sooner and with greater magnitude than I have guessed, that will be the kind of lagniappe I enjoy sampling these days.

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Disclosure: I/we have a beneficial long position in the shares of MSFT 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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