DA Davidson analyst Gil Luria downgraded Microsoft (MSFT) from Buy to Neutral but kept his price target at $475.
Luria noted that competition has effectively caught up with Microsoft in the AI space, making the current premium valuation less justifiable.
The analyst currently ranks Microsoft No. 4 in “The Magnificent Six.” The company’s shares have risen 92% since the analyst took over in January 2023, compared with a 49% increase in the S&P 500 index.
Luria noted that Microsoft, as the first company to adopt and commercialize generative AI, has accelerated growth and expanded margins over the past few quarters. The company’s early investment in OpenAI and ability to rapidly deploy features within Azure and GitHub have helped it build a large lead over Amazon.Com Inc (AMZN) Amazon Web Service and Alphabet Inc (GOOG) GOOGL Google Cloud, leading to superior financial results over the past four to six quarters.
Analysts said Microsoft’s lead in both the cloud and code-generation businesses was eroding, making it difficult for the company to maintain its lead.
Luria said AWS is already growing its cloud business nearly as much as Azure after several quarters of Microsoft expanding its business, and Google Cloud Platform’s expansion has also accelerated its business to a similar growth rate as Azure last quarter.
According to a new proprietary analyst analysis of hyperscaler semiconductors, AWS and GCP are well ahead in deploying silicon in data centers, giving them a big advantage over Azure in the future.
He noted that Microsoft is discussing its own Maia chips, but is years behind Amazon and Google and appears to only be using them to run Azure OpenAI Services workloads. Luria noted that this means Microsoft is escalating an arms race it likely won’t win. He said this makes Microsoft beholden to Nvidia Corp NVDA, which means wealth continues to shift from its shareholders to Nvidia shareholders.
Microsoft saw strong margin expansion last year, but now expects its operating margin to decline to cover data center capital expenditures, which Luria stressed will grow from 12% of revenue to 21% — a faster increase than Amazon or Google, due to Microsoft’s heavy reliance on Nvidia.
Analysts said Microsoft has been overinvesting by this percentage every year, cumulatively causing margin declines of at least 100 bps. To offset the decline in margins, Microsoft would have to lay off about 10,000 employees for each year of overinvestment.
Nvidia and others point to the high ROI of hyperscalers such as Azure, but Luria warned that those benefits may only last for a while.
Analysts noted that Azure’s growth could be driven by self-funded revenue from the likes of OpenAI.
Luria noted that Microsoft has also lost a large part of its lead over GitHub Copilot. Not only have Amazon and Gitlab nearly caught up with GitHub Copilot’s features, but Cursor has become the new standard, he said.
Luria forecasts first-quarter fiscal 2025 revenue of $64.2 billion and EPS of $2.96.
Price Action: MSFT shares were down 0.50% at $433.10 as of last check on Monday.
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