Microsoft (MSFT 1.79%) and Alphabet (GOOG 1.00%) (GOOGL 1.07%) are two of the world's most well-known tech companies. Microsoft owns Windows, Office, and Azure -- the world's second largest cloud infrastructure platform after Amazon (AMZN -1.48%) Web Services (AWS). Its Xbox business also makes it a leading video game company, it sells its own Surface PCs, and its Bing search engine gives it a firm foothold in the search and advertising markets.
Alphabet's Google owns the world's largest search engine, mobile operating system, web browser, webmail platform, and streaming video platform. Its Google Cloud Platform (GCP) is also the world's third largest cloud infrastructure platform.
Microsoft and Alphabet operate different business models, but both companies have significantly ramped up their investments in the artificial intelligence (AI) market in recent years. Which of these tech giants is a better play on that secular trend?
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Microsoft's big investments in OpenAI are paying off
Five years ago, Microsoft invested $1 billion in OpenAI, a developer of generative AI tools. It invested another $10 billion in the company last year, shortly after the initial launch of its ChatGPT chatbot. It also secured a non-voting observer seat on OpenAI's board last November after an internal conflict led to the brief firing and reinstatement of its CEO Sam Altman.
Microsoft officially refers to OpenAI as its "strategic partner", but it's been directly integrating the start-up's generative AI tools into Azure, Office, Bing, and Windows to automate, accelerate, and analyze certain tasks.
Those AI upgrades are enabling Azure -- the core growth engine of the Intelligent Cloud business which generate 43% of its revenue in its latest quarter -- to grow faster than AWS and GCP. Its "Azure and other cloud services" revenue rose 31% year over year in the third quarter of fiscal 2024 (which ended on March 31), accelerating from its 30% growth in the second quarter and 29% growth in the first quarter.
The rapid expansion of Microsoft's cloud and AI businesses is offsetting the slower growth of its PC, gaming, and enterprise-facing software businesses. Its operating margins still expanded year over year in the first nine months of fiscal 2024, even as it scaled up its AI infrastructure and integrated its recent acquisition of Activision Blizzard.
Analysts expect Microsoft's revenue and earnings to grow 15% and 19%, respectively, in fiscal 2024 (which ends this June). For fiscal 2025, they expect its revenue and earnings to increase 14% and 15%, respectively.
Alphabet's AI efforts are off to a rockier start
Alphabet's Google developed plenty of machine learning and AI algorithms to process the massive amounts of data across its ecosystem, but it's arguably falling behind Microsoft in the generative AI race. Google had been developing its own large language model (LLM) called LaMDA, but it wasn't publicly available when OpenAI's ChatGPT arrived in late 2022.
ChatGPT's launch drove Google to accelerate its development of LaMDA and roll out its own generative AI chatbot called Bard in early 2023. It subsequently merged Bard with its Duet AI assistant to create the unified Gemini platform.
Gemini wasn't as warmly embraced as ChatGPT, and Google suspended its image generation tools earlier this year after it generated historically inaccurate pictures. Many critics also claimed it was trained with left-leaning biases.
But like Microsoft, Google also integrated Gemini into GCP, and that closely watched business is generating accelerating growth. In the first quarter of 2024, Google Cloud's revenue increased 28% year over year, accelerating from its 26% growth in the fourth quarter and 22% growth in the third quarter. However, Google Cloud is still significantly smaller than Azure and only generated 12% of Alphabet's total revenue in the first quarter.
Alphabet still generates most of its revenue from Google's advertising business, which recovered over the past year as the growth of YouTube and its search-based ads offset the stagnant growth of its advertising network. It's also been locking more users into its YouTube Premium and Music subscriptions to diversify its business away from macro-sensitive ads.
Alphabet is more of a digital advertising company than a cloud and AI one, but its operating margins still expanded year over year in 2023 and the first quarter of 2024 as it trimmed its workforce and streamlined its spending. Analysts expect its revenue and earnings to grow 11% and 18%, respectively, in 2024.
The better AI play: Microsoft
Microsoft trades at 30 times forward earnings, while Alphabet has a slightly lower forward multiple of 25. However, I believe Microsoft deserves its higher valuation for four reasons: it's growing faster, its better diversified, its AI ambitions are clearer, and it generates more cloud revenues than Alphabet. Those strengths make Microsoft the better AI growth play right now.
