Microsoft in focus as DA Davidson downgrades on AI competition concerns

Microsoft (NASDAQ:MSFT) was in the spotlight on Monday as research firm DA Davidson downgraded the tech giant, citing the belief that the competition has caught up to it regarding its artificial intelligence prowess.

Shares fell 0.4% in premarket trading.

“We believe that Microsoft’s lead is now diminished in both the cloud business and code generation business, which will make it hard for MSFT to continue to outperform,” analyst Gil Luria wrote in an investor note. Amazon (AMZN) Web Services is “adding nearly as much cloud business” as Azure after a period of a few quarters, while Google (GOOG) (GOOGL) Cloud has also seen accelerating growth in recent quarters, Luria added.

Luria downgraded Microsoft to Neutral from Buy and kept his $475 price target.

Additionally, Amazon and Google appear to be “far ahead” in terms of deploying custom silicon into their respective data centers, with Microsoft “years behind” the duo, despite the introduction of its AI-focused chips, known as Maia, late last year.

“We believe this makes Microsoft beholden to NVIDIA (NVDA), which means it will continue to shift wealth from its shareholders to NVDA shareholders,” Luris added. “After significant margin expansion last year, Microsoft is now guiding for a decline in operating margins in order to pay for the data center capex increasing from 12% of revenue to 21% of revenue. This is a higher rate of increase compared to Amazon and Google, a result of Microsoft’s greater reliance on NVIDIA.”

Assuming Microsoft continues to “overinvest” at current rates, margins will decline by “at least” 1 percentage point in a cumulative manner and the company would have to lay off roughly 10,000 employees for every year of over-investment in order to keep margins roughly the same, Luria explained.

“While NVIDIA and others have pointed to a strong ROI for hyperscalers such as Azure, these returns may not last. We believe this ROI does not account for the precipitous decline in $/GPU rates already observed, and relies more on Microsoft’s ability to pass through current high rates in long term deals, due to the current scarcity in supply combined with customer FOMO.”

Lastly, Microsoft appears to have lost “much of the lead” for GitHub Copilot, as Amazon and Gitlab (GTLB) appear to have caught up to its capabilities, Luria said.

Analysts are largely bullish on Microsoft (MSFT). It has a BUY rating from Seeking Alpha authors, while Wall Street analysts rate it a STRONG BUY. Conversely, Seeking Alpha’s quant system, which consistently beats the market, rates MSFT a HOLD.