Goldman Sachs reaffirmed its positive outlook on Microsoft, setting a target price of $515 in a recent report. The focus was on the company’s investments in generative AI (Gen-AI). Despite concerns about the return on investment, the analysts drew comparisons to Microsoft’s successful development of Azure cloud computing.
The report highlighted similarities in the CapEx efficiency of Microsoft’s Gen-AI to the early stages of Azure’s development. Even though Gen-AI has only been around for about a year, it is showing promising returns. The company has managed to balance rapid CapEx growth with revenue generation from AI, a model that differs from the trajectory seen during Azure’s development.
While AI revenue is currently generating positive gross profits, depreciation is outpacing revenue, leading to a dilution in gross margins. The analysts estimated that without these investments, Microsoft’s gross margins could be higher. However, they also pointed out that AI-specific gross profits in FY24 are already comparable to Azure’s achievements eight years after its launch.
The report also noted an increase in Microsoft’s operating margin since Azure started contributing significantly to revenue. Despite a contraction in gross margins during this period, the analysts are optimistic about the trajectory of Gen-AI. They expect AI-driven revenue to grow faster than Azure did, with the potential for improved margins as the scale of operations increases.
Analysts foresee Microsoft reaching critical mass for Gen-AI much faster than it did for Azure, which took seven years. They anticipate slower CapEx growth and better margins as the AI segment gains momentum. Overall, the report from Goldman Sachs paints a positive picture of Microsoft’s foray into generative AI and its potential for long-term success.
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