Soft power

On Wednesday afternoon Microsoft’s shares touched $405.63, and for a few hours the company in Redmond was worth more than $3trn.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} It had got there with a rise of nearly 57% in 2023, against 48% for Apple.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} By the close the shares had slipped to $402.56, which left the market value at $2.99trn, a hair short of the mark and, on the day, still behind Apple.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} A milestone held for an afternoon suits a company that spent much of the 2000s being written off.

The two firms have traded the title of most valuable listed company since the start of the year, and Apple briefly lost the top spot to Microsoft earlier in January.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} The contest is revealing less for who leads than for why. Apple is the bigger earner. In its fiscal 2023 it booked $383.3bn of sales and $97.0bn of profit, though sales fell by 3%.^{6SEC EDGARApple Inc. Form 10-K for fiscal year 20233 Nov 2023} Microsoft made $211.9bn in revenue, up 7%, and $72.4bn in net income.^{3Microsoft Investor RelationsMicrosoft Cloud strength fuels fourth quarter results (FY23 Q4)25 Jul 2023} At Wednesday’s prices that puts Microsoft at about 41 times its last full year’s profit and Apple at about 31 times. Investors are paying a premium of roughly a third for the firm that makes less money. That premium is a bet on artificial intelligence.

It is not an absurd bet. Microsoft moved early. In January 2023 it announced a “multiyear, multibillion dollar investment” in OpenAI, and said that Azure, its cloud, would be OpenAI’s “exclusive cloud provider”.^{4Microsoft Official BlogMicrosoft and OpenAI extend partnership23 Jan 2023} It then folded OpenAI’s technology into Bing and its productivity software.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} Results have followed. In the quarter to September, revenue rose 13% to $56.5bn and Azure grew by 29%.^{2Microsoft Investor RelationsMicrosoft Cloud strength drives first quarter results (FY24 Q1)24 Oct 2023} Satya Nadella, Microsoft’s chief executive, put it in his usual register: “With copilots, we are making the age of AI real for people and businesses everywhere.”^{2Microsoft Investor RelationsMicrosoft Cloud strength drives first quarter results (FY24 Q1)24 Oct 2023} The market has taken him at his word. Brad Reback, an analyst at Stifel, told Reuters that AI sentiment favours Microsoft, while Apple lacks a “clear AI story”.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} Apple also faces slowing iPhone demand in China, where it is offering rare discounts against Huawei.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024}

We think the enthusiasm is mostly deserved and partly premature. Deserved, because Microsoft is doing what a good incumbent should do, which is spend its own money to be disrupted before someone else does it. It chose a partner rather than a rival, and put its cloud where its mouth was. Premature, because the money that justifies $3trn has not yet been counted. Microsoft began selling Copilot for Microsoft 365, its AI assistant for office workers, in November at $30 per user per month.^{7Microsoft Copilot BlogAnnouncing Copilot for Microsoft 365 general availability and Microsoft 365 Chat21 Sept 2023} Whether employees will use it enough for their managers to keep paying is a question that spreadsheets, not press releases, will answer. Azure’s growth of 29% is excellent, and up from 26% in the quarter to June.^{3Microsoft Investor RelationsMicrosoft Cloud strength fuels fourth quarter results (FY23 Q4)25 Jul 2023} But a share price with this much optimism in it needs the trend to keep improving, which trends seldom oblige.

The strongest objection is that Microsoft has built a durable advantage that deserves a premium. It owns the places where office workers spend their days, and it has a head start with the most talked-about models. That is true. But a head start rented from a partner is not the same as a moat. Microsoft’s blog post describes a partnership, not ownership, and the financial terms were not disclosed.^{4Microsoft Official BlogMicrosoft and OpenAI extend partnership23 Jan 2023} Reuters calls Microsoft a frontrunner in generative AI, and a frontrunner is a position, not a result.^{1Reuters, via Investing.comMicrosoft hits $3 trillion market value24 Jan 2024} A pro-competition newspaper should welcome that. It is also the best reason for shareholders to be cautious, since the premium assumes that AI profits will pool in Redmond rather than be competed away.

Apple, for its part, can take some comfort. Its profit is larger, and its fiscal fourth-quarter revenue of $89.5bn, though 1% lower than a year before, came with earnings per share up 13%.^{5Apple NewsroomApple reports fourth quarter results2 Nov 2023} Its absence from the AI conversation may yet prove to be patience. It may also prove to be absence. The market has not decided, and it rarely announces its verdict in advance.

For now the scoreboard reads about $3trn apiece, give or take a rounding error. Microsoft’s task is to prove that the software was worth the wait.