AI Hype Tests Big Tech’s Budget Discipline – 8/7/2023 – Tech

For tech investors, generative artificial intelligence (AI) fueled a strong rally this year, helping to lift the entire US stock market. While companies in the industry have been very willing to predict big things for the technology, one thing has been noticeably lacking: accurate predictions of exactly when generative AI will impact the industry’s finances.

That uncertainty has gained momentum in recent days as some of the biggest companies released their latest earnings, prompting a barrage of questions about the technology’s likely effect on costs and revenues.

Earnings for the first batch of the biggest US tech companies — Alphabet, Amazon, Apple, Meta and Microsoft — in the second quarter beat expectations. But like other companies hoping to get a boost from generative AI, they aren’t prepared to predict when new artificial intelligence capabilities will appear in their products and services or how much they expect to charge for the technology, much less the financial implications.

This Thursday (3), after Amazon and Apple concluded the most recent round of quarterly earnings announcements, Jefferies analyst Brent Thill summed up the mood among investors: “The baseless optimism is here, the no recipe”.

Despite the frustration, the earnings season at least helped sustain the big increases in share prices this year, with Meta, Amazon and Apple all up more than 50%. Unusually for a group of companies that often seem obsessed with growth, cost discipline has played a central role in improving earnings performance after a rare round of layoffs earlier this year. Amazon cut about 27,000 jobs, while layoffs at Google saw its headcount drop by nearly 9,000 people in the second quarter.

Amazon, in particular, has finally shown signs of getting its rising costs under control, after rising in 2022. Its operating profit margin rose to 5.7% in the second quarter, two points higher than in the first months of the year, and his best performance in two years. The surprise recovery boosted its shares by nearly 9% in post-close trading, adding about $120 billion to its market value.

Apple, which reported a 1% drop in revenue as consumer spending on electronics remained sluggish, also leaned heavily on cost containment in response to a shaky economy.

“We know that this has been an uncertain period, in recent quarters”, said the company’s Chief Financial Officer, Luca Maestri. “We have been quite effective in reducing the pace of spending.” He added that Apple was “very pleased with our ability to slow some of the spending growth,” even as it has consciously increased the pace of its research and development spending.

Despite increased attention to costs, however, a new wave of investment driven by generative artificial intelligence is already starting to emerge, raising questions about whether big tech’s spending discipline will be short-lived.

“The belt-tightening that happened in late 2022 and early 2023 was a moment in time,” said Jim Tierney of AllianceBernstein, which invests in growth stocks. “Will the strong margin recoveries in 2023 be fleeting?”

Microsoft, which was the fastest company to incorporate generative artificial intelligence into its existing products and services, is expected to register the increase in spending first. Equity investments in its latest quarter, at $10.7 billion, were larger than Wall Street had expected. The software company said spending would increase further in each quarter of its current fiscal year, which began in July.

Morgan Stanley analysts predicted that would bring Microsoft’s equity investments in things like data centers and the equipment to run them to $50 billion over the next 12 months. That would represent a year-over-year increase of more than 50% and more than double their spending just two years ago.

Chief Executive Satya Nadella said Microsoft would be able to tie this increase in spending to revenue growth as AI services take hold, describing the planned investment as “replacement capital plus some new capital that goes drive new growth”.

Other companies were less willing to predict exactly when the AI ​​investment boom will hit, though they did point to some higher spending in 2024. Meta’s chief executive, Mark Zuckerberg, said he couldn’t predict. “how quickly our new AI products will grow,” leaving the company without “clear control” over how much it would need to invest.

Zuckerberg was one of the tech executives to insist in recent days that, even in anticipation of an increase in spending, his newfound self-control with costs would remain in place. At companies like Amazon and Facebook, that could lead to a period of rising revenue and expanding margins, Jefferies’ Thill said. “It’s the return of growth with better margins, it’s not growth at any cost.”

Pressed by investors to say when they would see an increase in AI revenue, Alphabet, Meta and Amazon pointed to existing services that rely heavily on investments made in the past. These services range from AWS’s machine learning platform for cloud computing customers to the AI-enhanced tools that Google and Meta offer their advertising customers.

However, when it comes to the new wave of generative artificial intelligence, predictions have been few and far between. Amazon Chief Executive Andy Jassy said on Thursday that the technology was in its “early stages” and that the industry was “just in the early stages of a marathon.”

Many customers of Amazon’s cloud computing division, AWS, see the technology as transformative, Jassy said, although “most companies are still figuring out how they want to use it, they’re figuring out how to train models.” He insisted that all parts of Amazon’s business were working on generative AI initiatives and that the technology “will be at the heart of what we do.”

“At the moment, the evidence is a little sparse” about what the effect on tech sector revenue will be, said AllianceBernstein’s Tierney.

Even Microsoft offered only a cautious forecast of when this would manifest itself in higher revenue. Amy Hood, the company’s vice president of finance, told investors on a conference call about its results last week that the impact on revenue would be “gradual” as features roll out and start to be noticed by customers. The caution did not live up to high expectations prior to the announcement of results, which caused the share price to fall by 7% in the following week.

“Behind the scenes, the entire industry is scrambling to figure out a business model [para inteligência artificial generativa]: how do we set the price? How are we going to sell it?” Thill said.

Translated by Paulo Migliacci