Analyst downgrades stock as Amazon, Google close gap

DA Davidson Analyst Gil Luria downgraded the rating on Microsoft Corp (NASDAQ:MSFT) from Neutral to Buy while maintaining a $475 price target.

Luria noted that the competition has essentially caught up to Microsoft on the AI ​​front, reducing the justification for the current premium valuation.

The analyst now ranks Microsoft fourth in the “Magnificient Six.” The stock is up 92% since its launch in January 2023, compared to 49% for the S&P500.

Luria noted that Microsoft has accelerated its growth and expanded its margins in recent quarters by being the first to adopt and commercialize generative AI. With an early investment in OpenAI and the ability to rapidly deploy features in Azure and GitHub, it has gained a significant lead over Amazon.com Inc. (NASDAQ:AMZN) Amazon Web Service and Alphabet Inc (NASDAQ:GOOG) (NASDAQ:GOOGLE) Google Cloud, which resulted in results that were higher than those of the previous 4 to 6 quarters.

The analyst noted that Microsoft’s lead is now narrowing in the cloud and code generation areas, making it difficult for Microsoft to continue to outperform.

Luria said AWS is already adding nearly as much cloud business as Azure after a few quarters where Microsoft added more business. Google Cloud Platform’s expansion also saw its business accelerate to growth rates comparable to Azure’s in the previous quarter.

The analyst’s new proprietary analysis of semiconductor hyperscalers indicates that AWS and GCP are far ahead in deploying their silicon in their data centers, giving them a significant advantage over Azure going forward.

While Microsoft has talked up its Maia chips, it is years behind Amazon and Google and appears to be using them only to run Azure OpenAI Services workloads, he noted. Luria noted that this means Microsoft has escalated an arms race that it may not be able to win. He said this leaves Microsoft beholden to Nvidia Corp (NASDAQ:NVDA), meaning it will continue to transfer wealth from its shareholders to Nvidia shareholders.

After significantly expanding its margins last year, Microsoft is now banking on a decline in its operating margins to fund data center investments, from 12% to 21% of revenue, Luria said. That’s a higher growth rate than Amazon and Google due to Microsoft’s greater reliance on Nvidia.

According to the analyst, Microsoft is overinvesting at this rate every year, reducing its margins by at least 100 basis points in total. To offset this margin decline, Microsoft would have to lay off about 10,000 employees for each year of overinvestment.

While Nvidia and others have pointed to strong returns on investment for hyperscalers like Azure, Luria signaled that those returns may only last for a while.

The story continues

The analyst noted that Azure’s growth could be driven by self-funded revenues, such as those from OpenAI.

Luria also noted that Microsoft has lost much of its lead over GitHub Copilot. Not only have Amazon and Gitlab largely caught up to GitHub Copilot’s capabilities, but Cursor has become the new standard, he added.

Luria forecasts revenue of $64.2 billion and EPS of $2.96 for the first quarter of fiscal 2025.

Price action: MSFT shares were down 0.50% at $433.10 at last check Monday.

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