A top-performing fund manager is selling Microsoft shares, citing concerns about the tech giant’s future profitability in the face of advances in artificial intelligence. Blue Whale Growth Fund chief investment officer Stephen Yiu said the fund has been reducing its position in Microsoft over the past six months. The Blue Whale Growth Fund held Microsoft from its inception until August of this year. The fund is up 16.6% since the beginning of the year. The fund returned 30.7% in 2023, significantly outperforming its benchmark and the S&P 500, which rose 26%. Yiu’s decision stems from his belief that Microsoft’s business model is about to change dramatically with the rise of generative AI. MSFT 1Y line “Microsoft’s business model is going to change dramatically on the back of generative AI,” Yiu told CNBC Pro at the Quality Growth Investor Conference in London earlier this month. Microsoft has been leading the way in the adoption of generative AI. The company has invested billions of dollars in OpenAI, the owner of ChatGPT, and is at the forefront of AI research and development. Microsoft is also actively integrating AI into its services, including developer platform GitHub and productivity software suite Office 365. At the center of fund managers’ concerns is Microsoft’s new AI-powered product, Office 365 Copilot, which is priced at an additional $30. There is a monthly fee per user in addition to the standard Office 365 subscription. While this may look like an increase in revenue, Yui suggested that it could actually lead to a decline in Microsoft’s profit margins. Microsoft reports that its productivity and business processes division, which includes Office 365 services, has seen margins increase over the past seven years. Operating profit margin rose to 52.2% this year from 36% in the June 2018 period, according to FactSet data. The sector has also consistently grown at double-digit rates, from $35.9 billion in 2018 to $77 billion this year. Yiu believes that while Microsoft’s gross margins may increase, profit margins on new AI-powered services are likely to be significantly lower than traditional software subscriptions. “Microsoft’s quality (revenue) over the next five to 10 years will be lower than it has been in the past,” Yiu explained. According to successful fund managers, the core of the problem lies in the increasing costs associated with providing AI services. Unlike traditional software, AI requires significant computing power and investment in hardware infrastructure. This change is largely due to the need for more expensive AI chips, such as graphics processing units purchased from companies like Nvidia or developed in-house, to power AI capabilities. While Nvidia’s chips are readily available, Silicon Valley companies can instead derive much of their profits from generative AI services. While in-house AI chips may lead to cost savings for Microsoft in the future, they will significantly increase costs for the company in the short term. Nvidia is currently one of the Blue Whale Growth Fund’s top 10 holdings. Additionally, because AI models constantly need to be retrained and updated, those costs are ongoing rather than a one-time investment. “They will forever have to invest in hardware and AI infrastructure to provide us with (AI) capabilities. And it will forever be more demanding because of (AI) learning and retraining. The feedback (loop) never stops,” Yiu emphasized. Yiu acknowledges that Microsoft’s absolute dollar profits are likely to increase, but believes the company’s return on invested capital will decline. But the consensus among Wall Street analysts is for Microsoft to rise 20% over the next 12 months, according to FactSet statistics.
