Microsoft & Alphabet Delivered Robust Q2 Results as the AI Battle Intensifies

Microsoft

The tech giant reported overall solid results on Tuesday, for Q4 FY2023 (period ended June 30), extending this year's run, but there were also reasons for concern. Net Income surged 18% y/y to $20.081 billion and Gross Margins rose as well. ^[1]

This is rather impressive, given the significant boost in Capital Expenditures to support cloud demand and AI infrastructure. The company expects spending to increase sequentially in each quarter of the current fiscal year, which started in July. ^[2]

Revenues hit new records at $56.189, but year-over-year growth remained below 10% for another quarter. What's more, forward guidance was disappointing, since Microsoft projects sales to fall in the range of $53.8-$54.8 billion in Q1 FY2024

Alphabet

The Google-parent reported on the same day as its rival, beating expectations across the board, with strong top and bottom lines for the second quarter of the year. Net Income jumped, to $18.368 billion, while Operating Margins inched higher to 29%. ^[3]

Revenue strengthened to $74.6 billion, although the 7% y/y growth is far from stellar. Google Search rose on both yearly and quarterly basis, to nearly $43 billion, remaining the largest growth contributor. YouTube ads sales increased by around 4.5%, to $7.665 billion, after the recent disappointments, while Google advertising surged in excess of $58 billion.

These figures are encouraging for the advertisement business in general, which shows signs of stabilization after the strong headwinds of recent quarters, due to high inflation, recession fears and other factors. Pitfalls still lay ahead though for Alphabet, as the European Commission charged the company with anticompetitive practices in the advertisement technology industry. ^[4]

Cloud Battle

The two mega-caps are rivals in the ever-important cloud business, with Microsoft occupying the second spot (23%) and Alphabet the third place (10%) in Q1, according to the Synergy Research Group. However, they are both far behind Amazon (AWS), which dominates the market with a 32% share. ^[5]

The Intelligent Cloud segment is Microsoft's largest revenue generator, having expanded by 15% y/y in Q4 FY2023 to almost $24 billion. The guidance for the current quarter though was underwhelming, since sales are projected to narrow to $23.3-$23.6 billion.

Things were more upbeat on the Alphabet side, since Google Cloud delivered Revenue of around $8 billion, up roughly 28%. The business turned profitable in Q1 for the first time since the firm started reporting this metric and Operating Income widened to $395 million in Q2.

Artificial Intelligence Face-Off

Generative Artificial Intelligence (AI) has emerged as the new battlefield in Silicon Valley, with Big Tech jumping on the bandwagon. Microsoft has the first-mover advantage, since it was able to quickly harness the power of its investment in OpenAI, which kick-started the AI craze late-last year, with the ChatGPT conversational chatbot.

Microsoft incorporated the generative AI capabilities into its Bing search engine, pulling it out of obscurity. This poses an existential threat to Google, since the technology has the potential to reshape internet search and undermine its market dominance.

Since then, Microsoft has expanded its AI portfolio and has already started monetizing the technology. Earlier in July, it announced a subscription service for a monthly fee, with which corporations will be able to use AI tools on products like Excel, Word and Teams. ^[6]

The AI boom appears to have taken rival Alphabet by surprise, but the tech giant is picking up pace, following the initial slow start. Its CEO announced the use of AI not only in the search engine, but also in other key products, including Gmail and Maps, during May's I/O event. ^[7]

The importance of generative AI was evident in yesterday's earnings reports. During the earnings call, Alphabet CEO Sundar Pichai highlighted the firm's progress on the field, acknowledging "an opportunity to reimagine many of our products, including our most important product, Search". Cloud services is another affected segment, where mr Pichai noted that "70% of gen AI unicorns are Google Cloud customers", a term typically referring to startups with above 1 billion valuation. ^[8]

Microsoft CEO Satya Nadella also touted AI progress, referencing a series of companies that use its AI enabled services and saying the firm "is in the lead" in regards to AI cloud workloads. ^[2]

Microsoft Still Ahead

Tesla and Netflix kicked off the earnings season for Big Tech last week, which showed that markets are focused on forward guidance. Microsoft's stock dropped in extended trading after the results, due to concerns around the performance of the current quarter, while Alphabet's shares rose on better than expected results and future optimism.

Alphabet is finding its AI rhythm, weaving the technology in various products and services, with markets reacting positively, after the initial disappointment from the slow start. Expectations were probably higher around its rival, but Microsoft is still ahead. It commands a greater market share in the cloud business and has the lead in race for AI supremacy, already monetizing its AI capabilities and posing an existential threat to Alphabet.