DA Davidson downgraded Microsoft (NASDAQ:) on Monday from Buy to Neutral, while maintaining a $475 price target.
The firm cited intensifying AI competition as the reason for the review, noting that competitors have largely caught up with Microsoft’s AI capabilities, “reducing the justification for the current premium valuation.”
The tech giant’s stock has risen 92% since January 2023, outpacing the S&P 500’s 49% gain over the same period.
Microsoft had previously taken a significant lead in both the cloud business and code generation by being the first to adopt and commercialize generative AI. This was largely due to an early investment in OpenAI and the rapid deployment of capabilities within its Azure and GitHub platforms.
However, DA Davidson now believes Microsoft’s lead has waned as Amazon (NASDAQ:) Web Services (AWS) and Google (NASDAQ:) Cloud Platform (GCP) have shown comparable growth rates and are closing the gap in cloud business additions.
“Our new proprietary semiconductor analysis for hyperscalers indicates that AWS and GCP are far ahead in terms of deploying their own silicon in their data centers, giving them a significant advantage over Azure going forward,” the analysts said.
Microsoft’s Maia chips are still years behind those from Amazon (AMZN) and Google (GOOGL), with current use limited to running Azure OpenAI Services workloads. This, analysts say, puts Microsoft in a tough spot in the growing data center arms race.
Microsoft’s reliance on Nvidia (NASDAQ:NVDA) for data center operations is also seen as a potential weakness, as it could lead to a shift of wealth from MSFT shareholders to NVDA shareholders. The company is now experiencing operating margin declines due to increased capital expenditures on data centers, which are growing from 12% to 21% of revenue.
“This is a higher rate of increase compared to Amazon and Google, a result of Microsoft’s greater reliance on NVIDIA,” the analysts note.
“Each year that Microsoft overinvests at these rates will depress margins by at least 1 percentage point on a cumulative basis. Microsoft would need to lay off ~10,000 employees for each year of overinvestment to offset the margin pressure.”
Finally, analysts expressed concerns about the quality of Azure’s revenue growth, which could be inflated by self-funded revenue from OpenAI.
Microsoft’s investment in OpenAI, which operates exclusively on Azure, could be seen as lower-quality revenue driving much of Azure’s recent acceleration. Additionally, competition in code generation tools has increased, with Amazon and Gitlab catching up to GitHub Copilot’s capabilities, and Cursor emerging as a new industry standard.
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