Microsoft Doubling Down In OpenAI (NASDAQ:MSFT)

Everyone knows ChatGPT. It is a smart coder, an intelligent writer, and an elegant Chat Bot. We all get used to search engines that pops up random pages with key words, and we dig into those links on the first or second page of search results in hoping to locate what we want. In contrast, ChatGPT now emerges as powered by all wisdom in the universe and it can actually hear us and respond to us. For the first time, search becomes a peaceful and delightful human-like dialogue.

ChatGPT prototype launched on 11/30/2022. Within five days of its launch, it attracted over 1 million users. There has been a rising theme of buying Microsoft (NASDAQ:MSFT) for the exposure of ChatGPT. This article mainly focuses on Microsoft’s long-term growth fueled by ChatGPT.

Microsoft’s Investment in OpenAI

The following figure shows Open AI’s past rounds of investments. Microsoft invested $1B in 2019. Also according to CNBC, “Microsoft is set to invest $10 billion in OpenAI as part of a funding round that would value the company at $29 billion, news site Semafor reported Tuesday. Microsoft will reportedly get a 75% share of OpenAI’s profits until it makes back the money on its investment, after which the company would assume a 49% stake in OpenAI.”

This means Microsoft is the biggest beneficiary of ChatGPT’s success.

Microsoft’s Growth Fueled by ChatGPT

$10B investment is a No-brainer that Microsoft will prioritize on its integration efforts with ChatGPT for all businesses that fit. In this section we discuss the top three levers Microsoft is pulling.

1. Bing-OpenAI Integration

According to Insider, “Microsoft could launch a new AI-powered version of Bing before the end of March. The AI would provide search answers beyond the standard list of links.” The ChatGPT-powered search will be able to provide users customized experiences that are both comprehensive and interactive.

In addition, Microsoft is expecting to leverage OpenAI’s DALL-E 2 technology to serve content creators. When content creators type a description of an image the Bing’s Create App will suggest AI-generated images.

If we expect Bing to attract more traffic, it would be possible for Bing to grow its Search Ad revenue share from 5% today.

2. Azure OpenAI Service

In 2021, Microsoft launched Azure OpenAI Service to provide businesses access to AI lab OpenAI’s technologies. Initially it was part of Azure Cognitive Services mainly for use cases such as language translation and text autocompletion. In 2022, Microsoft expanded to developer-centric products (e.g. generating human-like software code), and analytical products (e.g. analyzing customer sentiments on the market). Cloud computing has revolutionized IT operations of companies of all sizes. It is not too crazy to expect AI on the Cloud to boost enterprise and start-up capabilities in Software R&D, Content Creation, Big-data analytics, etc. Microsoft/Open AI could potentially lead the revolution.

AI application could play an important role in optimizing total cost of ownership for Cloud customers. As a reminder, Azure currently has 21% of market share according to Statista.

3. Integrating OpenAI’s GPT into Office Products and Productivity Apps

On human efficiency side, the biggest win would be through the integration of OpenAI and Microsoft Office Products as well as Productivity Apps.

I am excited by just imagining how much working hours I have spent on repetitive tasks such as searching emails by key words, writing courteous responses, drafting emails or documents with uncertain word choices or problematic sentence structures, and searching pictures to accompany the PowerPoint themes, etc.

Finally, for productivity apps such as Microsoft Team, what if meeting notes can be recognized based on verbal discussions and auto-generated right after the meeting is wrapped up?

There are a variety of ways for Microsoft to use the power of OpenAI to amaze customers across different business lines.

4. Microsoft Stock Valuation

MSFT is currently traded at $239.23, -21% TTM. This represents 26x P/E. I would not bet much on the financial upside in 2023 considering it takes time to integrate, test, and boost business growth. If we use P/E multiple for valuation, the near-term upside will come from P/E multiple increase as we expect ChatGPT to enhance MSFT’s future capabilities of growing market shares across Search and Cloud.

If we apply 30x P/E MSFT will be worth $300, which represents 26% upside from its current price.

5. Risks with the OpenAI Thesis

Clearly the marketing is reacting positively to the benefits of Microsoft plus OpenAI. There are several things that investors should be aware, as they may affect how soon and how much the thesis will be played out.

First, it still takes time and a ton of industry efforts for the world to enjoy AI’s commercialization at scale, e.g. critics such as AI’s failure to provide sources and falsifying information.

Second, running generative AI models will consume high computing and energy costs. AI investments require crisp use cases, and good measurements of success.

Finally, AI development, application, and commercialization represent industry-wide efforts. Right now OpenAI dominates the media with its recent launch, but it does not mean it is the only winner in this space. The progress of AI will eventually create value for all companies putting in their efforts (either internally or via strategic investments).