DA Davidson analyst Gil Luria has downgraded Microsoft Corp (MSFT) from Buy to Neutral, while maintaining a price target of $475. This move comes as Luria believes the competitive landscape in the AI arena has significantly shifted, diminishing the justification for Microsoft’s current premium valuation.
Luria, who now ranks Microsoft fourth within the ‘Magnificent Six,’ highlighted Microsoft’s remarkable growth trajectory since his January 2023 initiation. The stock has surged 92% during this period, significantly outperforming the S&P 500’s 49% gain. Microsoft’s impressive performance stems from its early embrace and commercialization of generative AI. Through strategic investments in OpenAI and the swift deployment of AI capabilities within Azure and GitHub, Microsoft initially established a commanding lead over rivals like Amazon Web Services (AWS) and Google Cloud. This early advantage translated into superior results for Microsoft over the past few quarters.
However, Luria argues that this lead is now fading. Both in the cloud and code generation spaces, Microsoft’s dominance is being challenged. AWS, after a period of catching up, is now adding nearly as much cloud business as Azure. Google Cloud Platform has also accelerated its growth, reaching comparable rates to Azure in the previous quarter.
Luria’s proprietary analysis of hyperscaler semiconductor deployments reveals a significant advantage for AWS and GCP. These companies are ahead in deploying their own silicon within their data centers, giving them a substantial edge over Azure in the future. While Microsoft has announced its own Maia chips, Luria notes they are years behind Amazon and Google and seem to be used only for Azure OpenAI Services workloads.
This situation, according to Luria, places Microsoft in a difficult position. It’s essentially escalating an arms race it may not win, becoming increasingly reliant on Nvidia Corp (NVDA). This reliance will continue to shift wealth from Microsoft shareholders to Nvidia shareholders.
Furthermore, after achieving significant margin expansion last year, Microsoft is now forecasting a decline in operating margins. This decline is attributed to increased spending on data center capex, which is projected to rise from 12% to 21% of revenue. This increase, Luria points out, is higher than Amazon and Google due to Microsoft’s greater reliance on Nvidia. He believes Microsoft’s consistent overinvestment in this area could result in a cumulative margin reduction of at least 100 basis points. To compensate for this margin drag, Microsoft would need to lay off approximately 10,000 employees for every year of overinvestment.
While Nvidia and others have highlighted the strong returns on investment (ROI) for hyperscalers like Azure, Luria warns that these returns may be short-lived. He notes that Azure’s growth could be partially fueled by self-funded revenue, such as from OpenAI.
Luria also emphasizes Microsoft’s shrinking lead in GitHub Copilot. He asserts that while Amazon and Gitlab have caught up to GitHub Copilot’s capabilities, a new standard has emerged: Cursor.
Luria anticipates Microsoft’s fiscal first-quarter 2025 revenue to reach $64.2 billion with an EPS of $2.96. As of Monday’s closing, MSFT stock is down 0.50% at $433.10.
