The software industry is currently at a pivotal moment, transitioning between two major cycles: Cloud Computing and Generative AI. This shift is compelling companies to decide which era of software they should prioritize for investment.
And that, says Goldman Sachs analyst Kash Rangan, is why investors will “increasingly demand investments be matched with tangible revenue contributions.”
The risk here, says the 5-star analyst, is that if we don’t begin to “see killer apps at scale,” investments in Generative AI may need to be scaled back.
Microsoft (NASDAQ:MSFT), however, should be able to avoid that fate.
“We believe the risk to Microsoft can be contained as CapEx (capital expenditures) headwinds would be alleviated and FCF estimates would be revised meaningfully higher,” Rangan went on to say. “We continue to see Microsoft’s rapid CapEx buildout as a necessary investment ahead of the structural shift to Gen-AI, which is likely to present a vast market opportunity across all layers of the AI technology stack.”
Although Microsoft has witnessed a “material sequential increase” in CapEx and in order to meet the demand for Gen-AI anticipates a prolonged period of “elevated capital intensity,” Rangan believes that the CapEx intensity for these investments is progressing more efficiently compared to previous cycles.
On a fundamental level, Microsoft’s ambitions in Generative AI hinge on its capacity to handle growing inferencing workloads, which demand more sophisticated server equipment and necessitate an intensified investment cycle similar to the Azure infrastructure build-out phase. Throughout the 10+ year cloud transformation, Microsoft demonstrated a “willingness to invest purposefully and aggressively,” often committing resources ahead of the revenue opportunities anticipated.
“We believe Microsoft’s current investment cycle underpins the same level of conviction in the promise of Gen-AI. Five quarters in, we see this playing out well as (based on our estimates) Microsoft’s AI-related CapEx buildout has a similar CapEx intensity (CapEx / Revenue) to Azure four/five years after its GA (launched in 2010),” Rangan noted.
The difference, however, is that revenue is growing at a faster pace, with AI-specific revenues projected to reach $34 billion in FY24 (per GS estimates), achieving a $3.9 billion run rate by F3Q24. This growth trajectory is equivalent to the revenue ramp-up seen in years six and seven (FY16/FY17) of the cloud computing cycle.
All told, seeing MSFT eventually “yielding strong returns on its Gen-AI investments,” Rangan rates the shares a Buy, backed by a $515 price target. The implication for investors? Upside of 15% from current levels. (To watch Rangan’s track record, click here)
Only one analyst is willing to go against the grain here. Their sole Hold rating is countered by 34 Buys, all culminating in a Strong Buy consensus rating for MSFT stock. The forecast calls for 12-month returns of ~11%, considering the average price target stands at $500.71. (See Microsoft stock forecast)
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Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
