Microsoft: The ChatGPT Threat Against Google Is Intensifying

Summary:

• Microsoft is reportedly looking to accelerate its development with ChatGPT and launch an update incorporating it into Bing with a launch by March.
• Microsoft has ambitions to double its ad revenue from $10B to $20B but didn’t provide a timeline.
• With the successful introduction of ChatGPT for public preview, the company likely sensed a fantastic opportunity to take share from Google.
• Will Microsoft be successful in its bid to add more points to Bing’s 9% market share?
• Google management elevated the ChatGPT threat as a “code red” situation late last year. The threat to Google’s search dominance could intensify with Microsoft’s efforts.

Microsoft Wants To Bring ChatGPT To Bing

The Information reported an exclusive on Microsoft’s (NASDAQ:MSFT) intentions to upgrade Bing (Microsoft’s search engine), leveraging its investments in ChatGPT to take on Google search (GOOGL) (GOOG) more aggressively. However, before any Google bulls get overly worried, Google is still the king, with an 85% market share compared to Bing’s 9% share.

Therefore, Microsoft has plenty of ground to make up before it can even dislodge Google as the default search engine from “over a billion people (who) depend on Google to search for information.”

Microsoft is reportedly considering launching a ChatGPT-enhanced version of Bing as soon as March. Interestingly, CEO Satya Nadella & team have been working on fusing OpenAI’s GPT technology into Bing since 2019. Considering the massive interest and signups for ChatGPT since its launch in late 2022, we believe Microsoft probably sensed an opportunity to accelerate its advertising ambitions.

Microsoft Likely Accelerating Its Ad Ambitions

Notably, Microsoft Ad leader Rob Wilk outlined the company’s ambitions to double the size of its $10B ad business to $20B but didn’t suggest a timeline. However, we believe that with the successful introduction of ChatGPT to the public for preview so far, Microsoft could be looking to seize the initiative.

Notwithstanding, we discussed in a recent Google article, highlighting why investors shouldn’t be unduly concerned over the threat of ChatGPT to its business model in the near term.

However, with Microsoft looking to accelerate Bing’s development, Google investors must pay close attention. Furthermore, there have been significant developments since then, as the NYT highlighted that Google CEO Sundar Pichai had grown increasingly concerned over the threat of ChatGPT.

Accordingly, Pichai declared ChatGPT’s threat as a “code red.” As such, “he has upended the work of numerous groups inside the company to respond to the threat that ChatGPT poses.”

However, it’s still too early to suggest that Microsoft’s accelerated work with Bing could see it gain significant share against Google in the near term. While Microsoft is a relatively small player in the search business relative to Google’s dominance, it’s still a big tech company. It also retained the top position in last year’s Drucker Institute’s annual Management Top 250 ranking of best-managed companies. Therefore, the company has a significant interest in ensuring that its ChatGPT experiment doesn’t cause major stumbles.

As such, the company still faces significant reputational risks that concerned Google over prematurely introducing a chatbot “revamp” of its search business. Investors should note that large language models (LLM) like OpenAI’s ChatGPT or Google’s LaMDA, are probabilistic models, not deterministic ones. Hence, Microsoft and Google must ensure they can integrate their LLM technology safely for their users.

Despite that, we believe Microsoft’s urgency to penetrate further in advertising is critical, given the intensifying headwinds in the cloud computing and consumer technology segments.

Ad Uplift Could Mitigate Slowdown In Others

Accordingly, MSFT was downgraded yesterday (January 4) by UBS (UBS) as it sees “Azure entering a steep growth deceleration.” Therefore, we believe the market is likely pricing in a tepid FQ2, seeing further execution risks with Microsoft Cloud’s growth slowdown.

Moreover, Microsoft has also been beset by the slowdown in consumer electronics, as its More Personal Computing segment saw flat YoY growth in FQ1. Notably, consumer electronics could remain weak through 2023 as macroeconomic headwinds intensify. In a recent WSJ interview, Samsung (OTCPK:SSNLF) also cautioned that “demand for tech gadgets (could) remain sluggish through this year as high inflation, rising interest rates, and a strong dollar weigh on sales.”

Moreover, the latest Fed minutes from its December FOMC conference suggest that the Fed is committed to its rate hikes (i.e., no early pivot as prognosticated by interest rate strategists).

As such, the gloom over consumer tech spending is likely to remain weak, which the Consumer Technology Association predicted could fall by 2.4% in 2023 (following 2022’s 2.9% YoY decline), as it sees increasing risks due to “a looming recession and inflation” impacting demand further.

Hence, we can understand why Microsoft is looking to penetrate further into the search advertising space, given Bing’s relatively low market share. As such, it could provide a significant uplift to mitigate the slowdown in other segments if it could accelerate its timeline to reach $20B in revenue, representing 10% of the company’s FY22 revenue.

Takeaway

And search advertising is a highly profitable business for Google, generating 55% segment margins, just below Play Store’s 60% margins, according to recent Bernstein estimates.

MSFT last traded at an NTM EBITDA of 15.9x, over its 10Y average of 14x. Hence, MSFT is not cheap relative to its long-term average. However, it hasn’t been this cheap since the COVID lows, and therefore, we believe proffer long-term investors another opportunity to get on board.

If Microsoft’s Bing developments could prove more successful than anticipated, it could lift buying sentiments further as Microsoft accelerates its advertising ambitions.

Rating: Buy (Reiterated)

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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