Google: Microsoft And ChatGPT Want To Disrupt Google Cloud (NASDAQ:GOOG)

Microsoft Corporation (MSFT) has caused consternation for Alphabet Inc. (NASDAQ:GOOGL, NASDAQ:GOOG) (“Google”) investors recently as it has sought to integrate OpenAI’s ChatGPT into its Bing search engine and other products.

Before Google could even respond accordingly, Microsoft CEO Satya Nadella went another step further by making Azure OpenAI Service generally available (GA), with ChatGPT integration “coming soon.” Nadella highlighted:

ChatGPT is coming soon to the Azure OpenAI Service, which is now generally available, as we help customers apply the world’s most advanced AI models to their own business imperatives. – Satya Nadella’s LinkedIn

Why now? It makes sense. ChatGPT is on fire as it makes waves, drawing plaudits and criticisms. The Wall Street Journal even published an article penned by a neuroscientist about whether AI could be on track to gain “consciousness.” As the debate continues about the benefits and ramifications of Generative AI, we have been taken aback at the pace at which Nadella is willing to extend its integration with a chatbot despite the legal and ethical implications fired against ChatGPT.

At the same time, Google CEO Sundar Pichai & team have yet to promulgate their response (at least not publicly) to Nadella’s enthusiasm, as Microsoft seeks to deepen its investment and partnership with OpenAI.

Stratechery’s Ben Thompson (previously bearish on Google) highlighted that a “Kodak moment” could bedevil Google if management didn’t take Microsoft’s threat seriously enough.

Thompson also argued that Google must sharpen and accelerate its diversification into other areas to mitigate the risks in its search advertising model. He stressed:

Google will probably be fine, and if they’re not fine, well, I doubt there is much the company could do about it anyways, at least as far as Search is concerned. What is smart is the continued diversification into other areas like YouTube (a massive beneficiary of AI), Google Cloud (doing better than you think), and hardware. – Stratechery: More on Google and AI; OpenAI, Integration, and Microsoft

Nadella is not going to let that happen so easily. We think Microsoft likely sensed blood and believe this is the moment to distract Google’s attention from furthering its cloud ambitions.

In its press release on the GA of its Azure OpenAI Service, Microsoft’s Corporate Vice President, AI Platform Eric Boyd accentuated:

Azure is also the core computing power behind OpenAI API’s family of models for research advancement and developer production. Azure is currently the only global public cloud that offers AI supercomputers with massive scale-up and scale-out capabilities. With a unique architecture design that combines leading GPU and networking solutions, Azure delivers best-in-class performance and scale for the most compute-intensive AI training and inference workloads. It’s the reason the world’s leading AI companies-including OpenAI, Meta, Hugging Face, and others-continue to choose Azure to advance their AI innovation. – Press Release on GA of Azure OpenAI Service

Is it a cause for concern? Azure clearly emphasizes its differentiation against its hyperscaler peers, including Google Cloud. As Google’s most promising growth driver in a potentially weak year for digital advertising and on track for profitability, we see it as a potential setback.

Microsoft has demonstrated its resolve to be the disruptor despite commanding the No.2 position in the Cloud IaaS market behind Amazon Web Services, or AWS (AMZN). With Google Cloud reportedly in a leadership transition as its top-ranking U.S. sales executive left, Microsoft likely sees the opportunity to make it into a dominant two-horse raise with AWS.

Can Google respond to the threat? Most definitely. While OpenAI has popularized ChatGPT, Google’s engineers “invented the transformer, the key technology undergirding the latest AI models.” We believe Google is not behind OpenAI and Microsoft in its AI capabilities, as Pichai & team have invested ahead of the curve. However, investors and Google’s customers need to see it sooner than later.

Moreover, with Nadella upping the ante, likely targeting Google Cloud’s competitiveness and hindering its drive for profitability, Google Cloud CEO Thomas Kurian needs to respond as soon as possible. Thompson also emphasized: “These [we are better] claims [by Google] are just that: claims, because there aren’t any actual products on the market.”

With Google scheduled to report its Q4 and FY22 earnings release on February 2, we believe analysts on the call will be dousing management with several questions relating to Microsoft and ChatGPT. Accordingly, we urge investors to assess management’s commentary carefully. Google needs to demonstrate that it has the will and ability to respond to Microsoft’s fundamental challenges.

GOOGL last traded at an NTM EBITDA multiple of 9.9x, well below MSFT’s 16.6x. It’s also well below its 10Y average of 12.5x, as it remains supported slightly above the two standard deviation zone under its 10Y average. In other words, GOOGL seems cheap, and we believe significant headwinds have been baked in.

So, unless you think Google could face an existential crisis that could see its ad empire and cloud growth driver crumble, we see an attractive level for investors to consider adding Google stock here.

Rating: Buy (Reiterated).