Microsoft becoming 'Death Star' of tech while optimizing faster into AI: Strategist

Microsoft shares are falling despite posting an earnings beat; the tech company is reporting slowing growth in its Azure cloud segment while it is "swimming out of its lane" and innovating faster than its competitors in the AI space. Baird Technology Desk Sector Strategist Ted Mortonson analyzes Microsoft's path forward in integrating artificial intelligence into its infrastructure, while taking a look at Google-parent company Alphabet's earnings and digital advertising revenues.

Video Transcript

- Big names here reporting. We are seeing stocks moving in the opposite direction. Let's start with the one that's under pressure here-- Microsoft. We're seeing a beat on the top and bottom line here. But it is about the decelerating growth here, particularly around cloud. What's your takeaway on that front?

- Well, first of all, Azure was the main focus here. They had guided 26% to 27%. They came in at 27%. I think a lot of people were looking for a higher number, you know, deliver on GenAI-- on loads of GenAI. It's very obvious that the enterprise now is still in this optimization stage of looking at their cloud spend. So that's a little bit disappointing. And people were looking at a higher number there.

- Is it unrealistic of investors to expect, though, a monetization of generative AI this soon in the game for even a powerhouse like Microsoft?

TED MORTONSON: That's the right point. But, you know, Satya has been very, very aggressive and his narrative on OpenAI. And I think people were looking for a little bit better on those loads. Generative AI is-- it's not a flip of the switch.

And you ask the right question. These are re-architectures of data stacks and infrastructure. And it does take a long time. So, you know, you can look about a year out. And you'll start to see it hit the model. But there is a fair amount of high expectations with Microsoft being up 46% year to date.

- Yeah, and, Ted, you know, you could argue, maybe there-- a pullback, a slight pullback is needed given the excitement, you know?

TED MORTONSON: Healthy.

- It could-- yeah, a healthy pullback, we should say. You know, when you look at Microsoft, always a good pulse of just where enterprise is spending right now. Given the deceleration we've seen on that front as well, what does that tell you about where companies are putting their money?

TED MORTONSON: I think this is the optimization trade. Everybody's really looking at their IT budgets pretty aggressively. That's nothing new. With our conversations with CIOs, Microsoft is kind of the death star of technology.

They are swimming totally out of their lanes. They're innovating faster than anybody else. They're using their $17 billion cash flow per quarter to really integrate AI into areas like development tools on GitHub, which I think is going to be very strong, as well as moving into security.

So when I talk to CEOs or our analyst tech team talk to CEOs, one thing comes out-- Microsoft is becoming a line item in budgets. And I think along with every single company in tech, those IT budgets are not infinite, special in '23.

- I think something that you just alluded to is really noteworthy here in that we've moved past this kind of hype phase or narrative selling cycle or part of the cycle for generative AI and for a lot of tech companies and even nontech companies that had said that they were going to be able to benefit and leverage from it. No doubt, that could be true. But now that we're in the prove it phase, how many other companies kind of across the spectrum here could be set to face some tough questions from investors and, ultimately, perhaps see their stock prices react in tandem?

TED MORTONSON: That's the right question. I mean, I'd sit on over 70 calls a quarter on tech. And I'd say 90% of the CEOs are saying they're generative AI companies. Some are. And some are somewhat imposters.

And I think you're going to see the companies where the emperors don't have clothes and then the companies taking massive share. It's more of a platform sell. And there's some infrastructure picks and shovels that are going to do extremely well. But not everybody is going to catch this wave. It takes a lot of free cash flow and a lot of engineers.

- Finally, Ted, we're watching shares of Alphabet moving in the opposite direction. Certainly, a number of things to hit on in terms of what investors are watching there. It is the monetization of their AI technology. It's also about the growth they've seen in YouTube and digital ad spend. What's the one that you think really is leading to these gains? I mean, to what extent are-- is a 6% pop here justified?

TED MORTONSON: It's-- you know, if you look at Google, Google is up, I want to say, about 39% year to date. So it's a little bit below the Microsoft gains. But it's all advertising. Advertising last quarter was somewhat muted. And this improvement on advertising is noteworthy. Also, I think as-- if you look at GCP, which is their cloud offering, it's solid growth of, you know, call it 28%.

So they're one of the big three between Amazon and Microsoft and very, very poised. From a cloud standpoint, it's an engineering company. And I think some of the GenAI, you know, privates are using GCP because it's much more flexible on APIs. And quite frankly, they've been a pioneer for a long time on AI infrastructure.

- Just lastly, while we have here, Ted, I mean, the Street has become used to hearing from Ruth Porat in one facet or another. And now, there's going to be transition as the search commences for a new chief financial officer. You know, what do you believe this next iteration of that position particularly could hold? Is it one of extreme cost measurement even more so than Ruth has done over the years and having to monitor where some of that spend is going out the door and where they're able to monetize very well oiled parts of their business?

TED MORTONSON: She's one of the best CFOs in the business, if not, you know, the top five CFOs in the business. And the investor community had a tremendous amount of trust with her. She was very much of a straight shooter and, quite frankly, had a very good command of the numbers.

So the person coming in is going to have to be that type of person. CFO communication is key with the institutional market. And, you know, Google's going to have a hard roll to find to really take advantage of having Ruth in the seat for so many years. It's been a-- it's been a blessing for the company. She's an all-world CFO.

- Certainly have been at the helm, the steady hands at the helm for many, many years. Ted Mortonson, it's good to talk to you today. Appreciate your insight.

TED MORTONSON: OK, all right, have a good afternoon.