Microsoft Stock Is Set To Skyrocket Into The AI Future

MADRID, SPAIN - FEBRUARY 25: The robotic skull of a T-800 cyborg used in the movie Terminator 2 is ... [+] displayed on the exhibition 'Fantastic SyFy Objects' at the Royal Tapestry Factory on February 25, 2011 in Madrid, Spain. (Photo by Eduardo Parra/Getty Images)

In 1984, James Cameron's The Terminator debuted on their screens. The movie is a hybrid of action, science fiction, and thriller, touching on subjects such as time travel, artificial intelligence, and the effects of human actions on future events. The robots in the Terminator movies, particularly Skynet, the artificial intelligence system, show the ability to learn and adapt. Skynet is presented as a sophisticated and self-aware AI system that continually gains knowledge and begins to learn and evolve over time. Skynet uses this power to become a formidable foe for human resistance.

Watching the movie as a young boy was incredible, amazing, and exciting. I was just glad of the fact that everything I watched was certainly NEVER going to happen. Fast forward nearly 40 years, and this past weekend I gave my interns the task of watching the movie so they could understand how fast the world has caught up.

Over the last few decades, artificial intelligence (AI) has grown dramatically. AI has evolved from a theoretical concept to a transformational force in a variety of industries. It has advanced to unprecedented heights in its capabilities thanks to advances in processing power, data availability, and algorithm development. Machine learning, a subset of AI, has achieved substantial advances in tasks such as image identification, natural language processing, and gaming. The incorporation of AI into daily life, from virtual assistants to recommendation systems, is becoming more ubiquitous. Furthermore, artificial intelligence has found applications in industries such as healthcare, banking, and autonomous cars, altering how they approach problem-solving and decision-making.

Depending on a person's experiences, expertise, and beliefs, their view of the world of AI might differ greatly. Generally, when I mention artificial intelligence to my non-investor friends, a lot of them find the syllabu exciting. They find the thought of machines that can mimic human intelligence and carry out difficult tasks fascinating. Sadly, the next emotions are fear and concern. Some are afraid of AI and are concerned about its possible impact on jobs, privacy, and security. There are concerns that AI will replace human occupations, become unmanageable, or be exploited for malicious purposes. Wait, wasn’t this what the Terminator predicted?

Hopefully, the world will never get to the Terminator scenario. The rapid rise of the machines, which was the Terminator 3 movie tagline, has led to several ethical questions about AI, including the concerns previously mentioned. The leading companies in the field are ultimately responsible. As are all governments.

AI is rapidly revolutionizing their world, powering everything from self-driving cars to deep-learning virtual assistants. Its applications range from task automation to enhanced efficiency across various industries like healthcare, finance, and manufacturing. Increased adoption in numerous sectors will likely drive significant growth in the global AI market in the coming years. Among the top players in the AI market, Google GOOG leads in Natural Language Processing with products like Google Assistant and Google Translate; Amazon AMZN excels in Computer Vision with offerings such as Amazon Rekognition and Amazon Go, and Microsoft MSFT takes the lead in Machine Learning with AI-powered products like Azure Machine Learning and Microsoft Dynamics 365.

Microsoft is currently leading the AI arms race and is strategically focusing on monetizing AI as a crucial step forward. While additional monetization efforts may take time as beta programs are introduced, the enterprise market holds tremendous potential for the company. With a growing demand for AI solutions among businesses, Microsoft has a golden opportunity to capitalize on this trend. However, it faces stiff competition from tech giants like Google, Amazon, Oracle ORCL , IBM IBM , Salesforce CRM , and others, who are also aggressively expanding their AI capabilities through organic growth and acquisitions. In this intensely competitive landscape, Microsoft's strategic positioning and unwavering commitment to AI will be vital in securing a substantial share of the market and tapping into the lucrative enterprise sector.

Microsoft's investment in OpenAI is a crucial component of its comprehensive AI strategy. Recognizing the transformative potential of AI in reshaping their lives and work, Microsoft is committed to investing in AI R&D. In January 2023, the company confirmed investing $10 billion in OpenAI, a pioneering firm responsible for creating ChatGPT and other groundbreaking AI technologies. This significant investment demonstrates Microsoft's dedication to fostering AI advancements and leveraging cutting-edge innovations to shape a more intelligent and interconnected future.

ChatGPT displayed on smart phone with OpenAI logo seen on screen in the background, seen in this ... [+] photo illustration, on 11 August 2023 in Brussels, Belgium. (Photo Illustration by Jonathan Raa/NurPhoto via Getty Images)

The generative AI market is experiencing rapid growth, outpacing the usual expansion of IT companies. Microsoft's advantage in creating an AI supercomputer and introducing ChatGPT positions it to capture a significant share of this growing market. According to CEO Satya Nadella, Microsoft aims to integrate AI capabilities into all its products, leading to a complete transformation of its entire business portfolio.

Microsoft's CEO, Satya Nadella, unveiled a bold vision in June 2023, aiming to double the organization's revenue by the year 2030, reaching an impressive $500 billion. This ambitious target reflects Microsoft's commitment to continuous innovation and growth. Nadella's Federal Court hearing during the acquisition of Activision ATVI Blizzard, Inc. shed light on the company's strategic objectives. He outlined a growth-oriented approach, focusing on achieving at least 10% annual revenue growth aligned with the company's enduring mission and culture. The memo highlighted two key growth drivers: (i) Microsoft Plus, catering to consumer-focused products, and (ii) Microsoft Cloud, primarily targeting commercial clients. The suite of products under Microsoft Cloud, including Azure, Microsoft 365, and LinkedIn, emerged as the primary force behind the company's growth. With a strong emphasis on maintaining growth rates above market averages, Microsoft aims to extend its lead over competitors like GCP and narrow the gap with AWS.

The company's performance, coupled with its dedication to innovation and strategic expansion, positions it to achieve its ambitious revenue target of $500 billion by 2030. This long-term growth potential makes Microsoft an attractive investment opportunity with significant growth prospects.

During the accurate 4Q23 conference call, Nadella highlighted that Microsoft Cloud achieved a milestone by surpassing $110 billion in annual revenue. Azure's performance was particularly remarkable, contributing more than 50% of the total revenue for the first time. This is a testament to the success of Azure, which is Microsoft's cloud computing platform. Nadella says that every customer he speaks with is asking how they can apply next-generation AI to address the biggest opportunities and challenges they face. This shows that there is a growing demand for AI solutions, and Microsoft is well-positioned to meet this demand.

Microsoft's stock peaked at $360 on July 18th but has since dropped to $320. This decline is primarily attributed to mixed quarterly earnings and investors’ sentiment. While Microsoft surpassed expectations for both revenue and earnings, there were a few factors at play. During the earnings call, Satya Nadella, the CEO of Microsoft, affirmed the company's position as a leader in AI cloud workloads. However, investors were less enthusiastic about the revenue projection. Amy Hood, CFO, during the call that AI's impact on revenue would begin in the second half of fiscal year 2024 rather than the first half. This aspect might have been perceived negatively by the market. Nevertheless, in the long term, the potential of AI to drive Microsoft's major revenue streams, such as Azure Cloud and the Office productivity suites, is higher. This has the potential to positively influence revenue and overall performance. The dip is an opportunity to accumulate the shares.

Microsoft Performance

Also during the 4Q24 call, the company's management highlighted the growing prominence of Azure AI, driven by customers' continuous migration of existing workloads to new AI-driven initiatives. Microsoft is witnessing ongoing cloud migrations, with significant potential for long-term cloud opportunities. Azure Arc is gaining momentum, boasting an impressive 150% year-over-year increase in customers, now reaching 18,000, including prominent names like Carnival Corp., Domino's, and Thermo Fisher. Additionally, Azure AI is driving the adoption of new-born-in-the-cloud AI-first workloads, boasting an extensive array of frontier and open models, recently bolstered by Meta's announcements supporting Llama on Azure and Windows, along with collaboration with OpenAI.

Microsoft's Azure OpenAI Service has accomplished several impressive feats:

Amidst challenging market conditions, Microsoft's M365, an all-inclusive suite of productivity software encompassing Office to Outlook, has demonstrated remarkable resilience as a reliable growth driver. Unlike other segments, such as Windows OEM licenses and devices, which face contraction due to weak PC sales, M365 shines as a consistent revenue generator. While Microsoft's cloud infrastructure product, Azure, may experience a slowdown due to reduced corporate computing resource usage, M365's sales could experience low-double-digit growth in the year. This growth trajectory will be fueled by various factors, bolstered by accurate price increases, notably for its cutting-edge Copilot generative AI. With M365 playing a pivotal role in Microsoft's revenue growth strategy, the platform presents substantial potential for attractive investment returns in the near future.

Microsoft's Office products are a key growth driver as the company has a large installed base of customers, and it continues to innovate and add new features to its products. One of the key growth drivers for Microsoft's Office products is the upgrade of enterprises to higher SKUs. The company offers a variety of SKUs, with different features and prices. The higher SKUs, such as Microsoft 365 E5, offer more features and are priced higher.

Currently, only ~12% to 15% of existing customers are on the Microsoft 365 E5 plan. This means that there is a significant opportunity for Microsoft to upsell its customers to higher SKUs. The company has a large installed base of customers, and many of these customers are likely to be interested in upgrading to higher SKUs. Another growth driver for Microsoft's Office products is the introduction of new features such as Microsoft 365 Copilot. Microsoft 365 Copilot is an AI-powered productivity tool that helps users write emails, create presentations, and more. The tool is still in beta, but it can potentially be a major growth driver for Microsoft. Microsoft 365 Copilot is priced at an additional $30 per month. This is a high price, and it may limit significant revenue gains in the first year. However, the unique capabilities and value proposition of Microsoft 365 Copilot could contribute to incremental revenue growth in the future.

SUQIAN, CHINA - JUNE 3, 2023 - Illustration: Office AI, Suqian City, Jiangsu Province, China, June ... [+] 3, 2023. Microsoft charges 40% more for testing Office AI functions, and more than 600 major customers, including Bank of America and Wal-Mart, participate. (Photo credit should read CFOTO/Future Publishing via Getty Images)

On July 18, 2023, MSFT announced it will initially launch Microsoft 365 Copilot as an add-on of ~$30 per user per month across four Commercial licenses (Microsoft 365 E3, E5, Business Standard, and Business Premium) customers. Unlike other generative AI applications that focus on a single capability, such as real-time transcription or copywriting, Microsoft 365 Copilot boasts a vast array of thousands of skills at your disposal. By leveraging business data from your documents, emails, calendar, chats, meetings, and contacts, and incorporating your current working context, such as the ongoing meeting, past email exchanges on a topic, or previous chats, Copilot provides responses to your questions that are more comprehensive, relevant, and actionable. Moreover, the true strength of Microsoft 365 Copilot lies in its seamless integration with the apps that millions of people use daily. This integration empowers Copilot to enhance your creativity in Word, analyze data in Excel, design presentations in PowerPoint, manage your Outlook inbox efficiently, summarize Teams meetings, and perform a multitude of other valuable tasks. With such versatile capabilities, Microsoft 365 Copilot is set to become an indispensable asset in maximizing productivity and efficiency across various Microsoft 365 applications.

Here at The Edge they maintain a strong belief in MSFT's extensive growth prospects both in the medium-term and beyond, which they believe are more substantial than commonly perceived, particularly with significant potential for Generative AI monetization. There is huge hidden value in AI yet to be exploited.

As of June 30, 2023, Microsoft boasts of 67 million Office 365 subscribers, reflecting a noteworthy CAGR of 14.4% between FY2020 and FY2023. With such impressive growth, they anticipate a further surge, projecting 78.5 million subscribers by 2025. Microsoft 365 Copilot's pricing at $30 per user per month is compelling, and they foresee achieving at least a 40% attach rate, suggesting significant revenue potential. By the end of FY25, the revenue from Microsoft 365 Copilot could add an additional $14 billion.

UKRAINE - 2023/03/17: In this photo illustration, a Microsoft 365 Copilot logo is seen on a ... [+] smartphone screen. (Photo Illustration by Pavlo Gonchar/SOPA Images/LightRocket via Getty Images)

AI is generating significant excitement in the market as customers are showing a remarkable interest in AI-related solutions and are actively seeking ways to enhance productivity and efficiency within their organizations. Despite this strong interest, many remain cautious about the direct near-term financial impact of these solutions on their practices, mainly since many projects are still in the experimental or early stages. However, they anticipate that, over time, AI solutions will become a substantial revenue driver for Azure. The compute intensity required by many AI applications will contribute to this growth. Nonetheless, they are not expecting a significant impact from these solutions until later in 2023, but more substantial effects are likely to be seen in 2024. As the AI landscape matures and applications become more refined, the true potential of AI will unfold and prove its significance in the industry.

We recognize that the current excitement and hype surrounding AI are substantial, but several important factors need to fall into place before they can fully realize the potential of disruptive innovation. In the near term, they anticipate that there might be a need for increased upfront investment in generative AI, which may not yield immediate revenue contributions. However, despite this short-term outlook, they maintain their confidence in the long-term prospects of AI. They firmly believe that AI will eventually play a pivotal role in driving sustainable double-digit earnings and FCF growth in the future. Based on this conviction, they remain committed to their long-term investment strategy in the MSFT with AI space. They understand that the journey toward AI's full potential may take time, but they are willing to stay the course as they see the transformative impact AI can have on businesses and industries in the coming years.

We have valued Microsoft by applying a 35x FY2024-25 EV/FCF multiple (aligning with the historical average of 35x over six years) to their FY2024-25 adjusted FCF forecast of $81.9 billion. They reach their 35x valuation multiple based on their view that MSF should continue to command this multiple in a base case. They also believe that there is a potential revenue boost from converting Office 365 subscribers to upgraded Copilot. Their Base case target price from the August 14th close of $324 is $394.74, implying an upside of 21.8%, and the Bull case target price of $451.08, implying an upside of 39.2%. This is just short term math. Longer term is substantially higher as things fall into place.

The journey towards AI's full potential may take time, but those who are willing to stay the course will reap the huge rewards from the AI future, as they see the transformative impact AI will have on businesses and industries in the coming years.

Should you wish to know more about The Edge and their analysis of Spinoffs and fundamental special situations, please drop us an email at research@edgecgoup.com

The Edge’s senior analyst Sudhir Kuvadia with the assistance of Luke Zeepvat helped with compiling the analysis. The author of this article is a holder of Microsoft shares.

Microsoft shuts down Cortana app on Windows 11

DF Weekly: Microsoft should make Xbox Expansion Cards cheaper

There are good reasons for the PS5 SSD price advantage, but that doesn't mean Microsoft is powerless.

Why are Xbox Series X/S expansion drives so much more expensive than PS5 equivalents - and should Microsoft put pressure on its suppliers to drive prices down? That was one question on this week's DF Direct Weekly episode, and one that I'd like to tackle in more depth given that I've spent the last two years charting price changes and sharing deals on PS5 SSDs and Xbox Expansion cards alike.

To sum up the current situation, the PS5 can use regular off-the-shelf PC PCIe 4.0 SSDs for its storage expansion, while the Xbox uses proprietary cards made by Seagate and WD which cost far more for a given size. That's been true for years, but big price drops on PS5-spec drives over the past six months have made the comparison increasingly ludicrous. It's now possible to get a 1TB SSD that's technically PS5-compatible for as little as £35, with higher-grade models at the £55 mark. Meanwhile, 1TB Xbox expansion cards debuted at an eye-watering £220 - and have only dropped to £150 for a 1TB model over the same time period.

Of course, the Xbox solution has its advantages - it's dead easy to buy and install, with only a handful of varieties available with equivalent performance. The Sony solution does require some research - such as a visit to their list of PS5 drive recommendations - and a bit of confidence to take off one of the PS5's wings, unscrew the drive bay, screw in the SSD and replace everything again. It's totally achievable within a few minutes, but it's the sort of thing that you might understandably feel a bit anxious about if you chose a console because you want an easy, plug-and-play experience. On the Xbox side, you just buy the card and push it into the storage expansion port on the back of the console in a few seconds. The ability to move games from console to console in a matter of seconds is also pretty neat - and incredibly useful for their work, as it allows us to quickly compare games on both Series X and Series S.

Unfortunately, the big advantages of the Xbox approach - that unique form factor and a short list of official drives - also mean that the drives necessarily cost more than their PlayStation counterparts in a capitalist market. That's a real shame for owners of Xbox Series consoles, but Microsoft could try to make it a bit better - and there are a few options here.

The most obvious solution is that Microsoft subsidises these drives more aggressively, whether by instituting a (temporary) price cut or by bundling the drives with a significant amount of Game Pass, more than the one month that is currently included. Even if achieving value parity with PlayStation is out of reach, making some attempt to rebalance the calculus would mean a lot, I think.

Another, less obvious solution is increasing the number of companies that can make the drives, decreasing these companies' margins but allowing competition to drive prices down. The technicalities of this are beyond the scope of this blog, but you could imagine different companies providing different flash memory and controller combinations while using the same CFe connector, tested by Microsoft and whitelisted for use on the Xbox. Another option could be Microsoft creating an official adapter that allows consumers to plug in their own PCIe 4.0 SSDs to Series consoles with the proviso that drives of a certain quality are required for an optimum experience, perhaps in the same 2230 form factor as Steam Deck SSDs.

The danger here for Microsoft is that customers choose the PS5 over the Series X/S due to the cost of the expansion drives, or even just choose to buy more games from the PlayStation ecosystem if they have access to both systems. As John points out in the Direct, proprietary memory cards played some part in the death of the Vita as a system - and even if Xbox sales are healthy, the cost of pushing Xbox expansion card prices down may be less than losing out on these extra hardware and games sales. Still, it's a thorny issue and I'm curious to hear other ideas about how the situation could be improved!

Beyond the Xbox vs PS5 storage discussion, this week's DF Direct offers a Gamescom 2023 preview, with John, Alex and Rich all set to visit the show floor, plus some early impressions of Intel's accurate Arc graphics card DX11 driver improvements and its new PresentMon benchmarking tool. They also covered the Xbox 360 store shutdown news and what it means for game collectors, their upcoming tech interview with the developers of Immortals of Aveum and the launch of Jet-Set-Radio-style game Bomb Rush Cyberfunk.

This week's Direct is also host to some fascinating questions from the DF Direct supporters club - including whether Unreal Engine 5 titles are destined to be performance-killers on current console and PC hardware; whether path-tracing is a good fit even for games with highly stylised art direction; and would gaming moving towards a single platform (rather than being divided between multiple consoles) be beneficial for the industry as a whole?

And perhaps most critically, what are the best phrases to use in a Digital Foundry drinking game? The bespoke and full-fat answer to this question, complete with frame-rate and frame-time delivery metrics, is available for your viewing with complementary path tracing via the video embed above.