Microsoft stock could rise 24% in the next year, according to TipRanks. Here are three forces propelling that upside:
- Microsoft dominates a highly profitable industry with an average net profit margin of 31%, according to IBISWorld.
- Microsoft’s software industry dominance could enable its ChatGPT-powered Copilot service add $30 billion to the company’s revenue.
- Microsoft’s 49% stake in OpenAI could be worth $100 billion, according to TipRanks.
One negative: Microsoft is losing money now on its Copilot due to the very high cost of operating ChatGPT, according to the Wall Street Journal. Over time, a combination of price increases and greater operating efficiency could enable Microsoft to solve this problem.
Given Microsoft’s 35.7% net profit margin, investors should focus more on whether Microsoft can exceed growth expectations than with what I think will be short-term losses on its Copilot operations.
Microsoft’s Profitable Industry
Microsoft is the largest software company in a huge, profitable industry. Specifically, in 2023 the software industry’s 48,422 companies generated $482 billion in revenue – having grown at a 5.9% average rate since 2018 — and earned a net profit margin of 31%, according to IBISWorld.
Overall, the profit potential of the U.S. software industry is high – thanks to the strong pricing power and customer loyalty of the largest companies such as Microsoft — which has 19.2% market share (number two is IBM
IBM
Microsoft is poised to win significant revenue from Generative AI software — an industry growing at 31% a year. How so? The most significant Generative AI software companies are among the largest publicly traded technology companies. This stands in sharp contrast to the leaders in the dot-com era – startups that grew quickly to win market share from incumbents.
In May 2023, analysts from investment firm NEA wrote, “Unlike with the prior shifts, incumbents do not need to re-architect their entire products to adopt this new platform shift. In addition, this shift favors companies with bigger, proprietary data sets which can give an edge to more established companies,” according to the New York Times
NYT
Unlike during the dot-com era, with LLMs Google and Microsoft had “huge head starts” in developing the technology and winning over consumers. While LLM startups such as OpenAI and Anthropic performed R&D, they could only gain access to the capital required to train their models through “Faustian ‘partnerships’ with tech giants,” the Times reported.
Despite Costs, How Copilot Could Add $30 Billion To Microsoft’s Revenue
Microsoft has not reported Copilot’s revenue. Earlier this year, I estimated Copilot could add $40 billion to its Microsoft’s top line. After two more recent developments, I lowered my Copilot revenue estimate to $30 billion.
What is Copilot? In April I wrote Microsoft 365 Copilot will enable customers to use natural language to create Word, PowerPoint, and Excel documents.
Word users will “highlight a paragraph and the AI can offer different options for a rewritten version of it.” PowerPoint users will be able to create presentations based on text from a document and add in images Excel users will deploy Copilot to analyze sales data, determine trends and create charts, the Wall Street Journal reported.
While I thought Copilot could add $40 billion To Microsoft’s top line this April, I now estimate that number at $30 billion.
I based the $40 billion on a March Credit Suisse report estimating ChatGPT could provide Microsoft an additional $40 billion in revenue over the next five or more years, according to Business Insider.
In July, a lower estimate of $14 billion emerged from Macquarie Equity Research — based on the assumption that 10% of Microsoft’s 382 million customers would pay CoPilot’s $30 a month fee.
My current estimate is $30 billion. On Monday, the Journal reported Microsoft was losing “on average more than $20 a month per user” with some customers costing the software giant as much as $80 a month due to the high cost of computing required to run the ChatGPT models. In order to reduce losses, Microsoft will raise its monthly fee to $60, the Journal wrote.
If that happens, Microsoft’s revenue from Copilot would reach $28 billion — which I rounded to $30 billion based on my assumption that 10% of users could be a bit low.
Microsoft’s $100 Billion Stake In OpenAI
Microsoft’s 49% stake in OpenAI could be worth $100 billion. Oppenheimer analyst Timothy Horan made that case, according to TipRanks.
Horan applied OpenAI rival Anthropic’s valuation of 250 times its $100 million in revenue for private fund raising round expected to raise $2 billion and value the AI startup at $25 billion.
With OpenAI generating an estimated $1 billion in revenue, Horan applied Anthropic’s 250 times revenue to value OpenAI at $250 billion — which he discounted slightly to estimate Microsoft’s 49% would be worth $100 billion, TipRanks noted.
Will Microsoft Beat Expectations For Its September -Ending Quarter?
Microsoft will beat its modest growth guidance for its fiscal first quarter ending September 2023 — which fell somewhat short of expectations. However, Wedbush analyst Daniel Ives is optimistic the software giant will do better when it reports in November.
Due to some deceleration in Cloud service Azure’s revenue, Microsoft guided for a range of first fiscal quarter revenue the midpoint of which, $54.3 billion — fell $640 million short of Wall Street expectations, according to TipRanks.
Ives expects Microsoft to exceed guidance. “We believe while management has talked about a ‘gradual ramp’ for AI monetization in FY24 we believe so far the adoption curve is happening quicker than expected based on our recent checks. Our latest Azure checks also show a clear uptick in activity sequentially (AI driven) which gives us further confidence in Microsoft exceeding its 25%-26% Azure growth guidance in FY1Q,” TipRanks wrote.
Where Will Microsoft Stock Go Next?
Microsoft stock will rise in the next year. Horan set a price target of $410 — implying a 24% increase from its price on October 10. Ives’ price target of $400 would give investors a 21% return.
Microsoft’s competitive position is very strong and if its Generative AI investment is likely to drive expectations-beating growth for years in the future — especially as the company lowers the costs of operating ChatGPT.
Read the full article here