GhatGPT has set the online world alight and sparked debate over the future of almost everything. We look at a monumental battle between two behemoths of the tech industry…

​The launch of ChatGPT has set the online world alight, amassing more than a million users within days and achieving the status as the fastest ever application to reach 100 million active users, in only 2 months. It has sparked debate over the future of almost everything, from education to copyrighting to medical treatment (note that this article was written by a real human).

If you’ve been living under a rock the past 6 months, ChatGPT was developed by OpenAI and released in November 2022, and is “an artificial intelligence trained to assist with a variety of tasks.” In simple terms, users can enter a query or request into a text box, and ChatGPT will process the request and respond using all of the information it has available. So far, users have done things like write short articles based on news content, provide travel recommendations, solve mathematical problems, and write and debug programming code.

In January, Microsoft (NASDAQ: MSFT) invested US$10 billion (A$14 billion) in OpenAI (on top of prior investments in 2019 and 2021), giving it a 49% stake in the company. This allowed Microsoft to integrate ChatGPT into its range of products and services, beginning with the Bing search engine and the Edge internet browser (the revamped “Internet Explorer” for those that long-ago switched to Google Chrome, Mozilla Firefox or other browsers). Microsoft has also begun to add ChatGPT to the Microsoft Office platform (most known for Word, PowerPoint and Excel) and its cloud computing platform, Azure.

Not to be left out of the race, the parent company of Google, Alphabet (NASDAQ: GOOG) has since launched its own artificial intelligence (AI) tool, called Bard. Alphabet’s Chief Executive Officer (CEO) Sundar Pichai has made AI a focus for the company the last several years, in an effort to maintain Google’s dominant position in search. Bard had an inauspicious start unfortunately, with the February 6 demonstration making an error when answering a question about the James Webb Space Telescope’s recent discoveries. Given the intense interest in AI technologies at the moment, this error attracted heavy criticism (and the Alphabet share price took a bit of a hit that day, although it has since recovered!).

​Alphabet (through Google) has an incredible position in the internet search market, with a staggering 90% share across the world (excluding places like China where Baidu dominates, and Russia, which has Yandex). Search is the company’s major profit engine, and for years (approaching decades), it has held the undisputed lead in the industry. Several weeks ago however, the New York Times reported that Samsung is considering changing its default search engine from Google to Microsoft’s Bing. There has been speculation about the default search engine on Apple devices over the years as well, and Google pays a tidy sum to Apple to keep the current arrangement in place. CEO Pichai responded that deals have always been competitive and that Google will continue to innovate and improve its search product to keep its dominance, but there’s no doubt competition is hotter than it has been for quite some time.

​As well as the battle over AI and the future of search, Microsoft and Google are also going head-to-head (or toe-to-toe?) in the cloud computing market. As a refresher, cloud computing is essentially the outsourcing of IT resources over the Internet. Instead of companies (and individuals) buying, owning and maintaining physical IT hardware (such as servers, storage, and computing power), cloud computing businesses now provide this infrastructure on a pay-as-you-go basis. This allows companies to increase or decrease the amount of IT infrastructure they have access to more quickly and at a lower cost, without needing specialist IT personnel in-house. Software also operates via the cloud nowadays, allowing the software providers to deploy updates more easily, giving users access to the most up-to-date version at the ready.

Amazon Web Services (AWS) historically had a dominant lead in this emerging field, having leapt ahead with a “first mover advantage.” Seeing Amazon’s success and believing they also had expertise in the field, both Microsoft and Alphabet have launched cloud computing companies. Both Microsoft Azure and Google Cloud Platform (GCP) have had good success, and the growth rate at AWS has slowed in recent times. This has had a heavy impact on  Amazon’s share price, given it makes up a huge part of the company’s profit.

​Market expectations were low heading into the “big tech” earnings season for the first quarter of 2023. Starting with Alphabet, which published its 1Q 2023 financial statements on April 25. Quarterly revenue increased 3% compared to the first quarter of the prior year, clocking in at US$69.8 billion. While this might look like lacklustre growth for the search giant, Alphabet had posted quite stellar results during the pandemic (at its search business and particularly YouTube businesses) and this was an acceleration from the final quarter of 2022.

Breaking down the financials, Google Advertising (which makes up most of Alphabet’s revenue) was US$54.5 billion, roughly flat compared to 1Q 2022 and a reflection of the more difficult macroeconomic environment. YouTube advertising declined from US$6.9 billion to US$6.6 billion, given the previously mentioned strong trading in the prior year. GCP (Google’s cloud business) was the standout surprise. Not only did revenue increase 28% from the prior year to US$7.5 billion, the division turned profitable for the first time. Other Bets (the more speculative division with life sciences unit Verily and self-driving car company Waymo) saw revenue decline by nearly half–which may prompt more pressure to spin-off or sell these businesses. Alphabet’s net income declined to US$15.0 billion (compared to US$16.4 billion a year ago), but impressively free cash flow (i.e., cash profit) increased 12% to US$17.2 billion and was higher than net income. To combat the recent advertising weakness, CFO Ruth Porat announced a multiyear cost-cutting strategy, which includes reductions in real estate and personnel, with 6% of the workforce (12,000 employees) laid off in January. Despite pressure on profitability in the quarter, Alphabet remains in great financial shape and the Board of Directors announced a further US$70 billion in share buybacks.

Microsoft also reported earnings on April 25 for the 3Q 2023 period (Microsoft uses the Australian financial year rather than the calendar year for financial reporting like most U.S. companies). Overall revenue increased 7% (10% excluding the impact of changes in foreign currency), net income increased 9% (14% ex-FX) and EPS of $2.45 was 10% higher than the prior period (14% ex-FX). There’s a fair few divisions in the modern Microsoft, which the company reports in three main segments: Productivity and Business Processes (Office, LinkedIn, Dynamics CRM), which increased revenue 13% or 17% ex-FX; Intelligent Cloud (Azure, server products), revenue increased 17% or 21% ex-FX; and More Personal Computing (Windows, Surface devices, Xbox, Bing), where revenue decreased 9% or 7% ex-FX. Microsoft returned $9.7 billion to shareholders using both dividends and share repurchases during the quarter. The company’s acquisition of Activision Blizzard (NASDAQ: ATVI) remains in limbo, with U.K. regulators recently turning down the deal, saying it would have an outsized impact on competition in the industry. It’s difficult to see how this will play out at this stage.

​Alphabet and Microsoft have been popular stocks among both professional and retail investors for the past decade–and with good reason. They have huge addressable markets, high levels of profitability, fortress balance sheets, and have shown consistent growth over many years. Their share price growth reflects these strengths.

2022 was a more difficult year for most investors, including holders of Alphabet and Microsoft shares, but the last quarter’s earnings reports did a good job of allaying fears that these companies are past their prime. Results exceeded Wall St and other pundits’ low expectations, and both companies have retained strong positions in their core markets. Cloud and AI are in their early days, and could well present the next decade of growth for both of these big healthy giants.

Disclaimer: ​NASDAQ: MSFT and NASDAQ: GOOG are currently held in TAMIM portfolios.