Microsoft extends cloud lead over Alphabet with focus on OpenAI, big clients

[October 25, 2023]  By Aditya Soni

(Reuters) -Microsoft is outstripping Alphabet in the race to make money from generative artificial intelligence through early bets on OpenAI and focus on big clients, raising worries that the Google parent could lose share in the cloud-computing market.

Cloud spending by businesses preparing to roll out AI features powered a rebound in growth for Microsoft's Azure platform in its first quarter, lifting the shares of the Windows maker up nearly 4% on Wednesday.

But in a sharp contrast, growth at Alphabet's cloud unit hit a near three-year low as its big exposure to smaller clients dampened growth, sending the company's shares tumbling more than 6%.

In the battle to tap the next growth driver for the cloud business, Microsoft has focused on its core business clients that already use many of its software services, while Google has turned to startups.

"Demand for artificial intelligence drove Microsoft's growth. Demand among Google's larger clients was similar, but the firm is more exposed to high-growth and startup clients, which have been more aggressive with cost-control efforts," Morningstar analyst Ali Mogharabi said.

If share losses hold, Alphabet was set to erase more than $100 billion from its market value, underscoring fears that its focus on startups and slower roll out of AI services was delaying the boost from the technology.

Gains in the shares of Microsoft were set to add about $90 billion to its market capitalization.

"Microsoft is using its incumbent software relationships, whereas Google is coming in as a little bit of a challenger here," said Krishna Chintalapalli, portfolio manager at Parnassus Investments, an investor in Alphabet and Microsoft.

The results show cloud spending is coming from enterprise clients, whereas smaller businesses are reducing their expenditure, he said.

Strong AI use was responsible for a 3 percentage point boost to the Microsoft's cloud business in the September quarter.

A view shows a Microsoft logo at Microsoft offices in Issy-les-Moulineaux near Paris, France, January 25, 2023. REUTERS/Gonzalo Fuentes/File Photo

CEO Satya Nadella said about 40% of the Fortune 500 companies were using the test version of its "Copilot" AI service, which is powered by OpenAI's technology.

The company will launch the $30-a-month offering next month for its 365 service that can summarize a day's worth of emails into a quick update.

Analysts said that will further drive up adoption of its AI services. Alphabet has also deployed AI in products such as its flagship Pixel phones and had more recently tested adding generative AI to its search engine.

"Unlike many others who are touting their AI story, Microsoft is capable of delivering meaningful AI products to their customers," brokerage D.A. Davidson said.

At least 19 brokerages raised their price targets on the software giant, pushing their median view to $400. That was 16% higher than the company's premarket share price of $342.78.

Many analysts were also optimistic about strength in Alphabet's core search business, but they warned the weakness in the cloud business would continue.

"It's unclear just how widespread Google Cloud optimization efforts are and how far along customers are in the journey, but expect these headwinds to persist for at least a few more quarters," Bernstein analysts said.

AI is expected to become more of a growth driver in 2023 for Alphabet after the expected roll out of Gemini, which is a collection of large-language models.

"Early results are very promising (for Gemini)," CEO Sundar Pichai said.

Microsoft trades at 28.5 times its 12-month forward earnings estimates, compared with the Google parent's 24.93.

(Reporting by Aditya Soni in Bengaluru; additional reporting by Akash Sriram; Editing by Arun Koyyur)

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