Key Takeaways
- The firm has lowered its rating for the pair of tech giants after years of maintaining an “above-consensus” bullish stance.
- “Gen-AI is not the new cloud 1.0,” Rothschild & Co Redburn’s analyst said.
Some of the firms in the Magnificent 7 are starting to look a bit less magnificent.
Rothschild & Co Redburn on Tuesday downgraded both Amazon (AMZN) and Microsoft (MSFT) to neutral from buy rating, a measure of cold water on backers of the AI rally—and on the shares, which are broadly beloved by Wall Street analysts. “We no longer see a bull case,” analyst Alex Haissl wrote. Shares of Microsoft and Amazon were down 2.7% and 4.4%, respectively, on a down day for markets.
The AI rally, which has driven broad market indexes to record highs, had already started to hit the skids. Between concerns about valuations, comparisons to the dotcom bubble, high-profile stock sales and earnings reports showing capital investments the payoff of which investors now see as less certain, enthusiasm has sputtered. Now, a sobering report on two of main characters in the AI-narrative lands right before Nvidia’s (NVDA) earnings, expected tomorrow.
Key Takeaways
There’s still plenty of bullish energy around AI, but investors are increasingly asking questions about whether the technology can lead to revenue that justifies the spending needed to build out the technology. That’s a major reason for the pressure on tech stocks lately.
The gist of the 61-page report is that generative AI costs more to develop than it generates revenue. Though the new technology is often compared to cloud computing in its early days, Haissl said that the capital intensity needed to develop Gen-AI is nearly three times higher, which would require prices to “rise materially” to make financial sense. Meanwhile, he argues, the effect of AI business on big cloud-computing business growth—upon which Microsoft and Amazon both heavily rely—has been overstated.
There is “no credible path back to ‘Cloud 1.0’ economics,” Haissl said. “The market, however, still prices in that outcome, implying returns we believe are no longer achievable—and this misalignment underpins our more cautious stance.”
The analyst said Amazon’s AWS is better-positioned than Microsoft’s Azure in terms of capturing value, but in order for him to take a more positive view on the pair, they each would have to show evidence that they are producing higher growth over a sustained period of time and reducing build costs.
The downgrade on Amazon and Microsoft follows years of the shop maintaining an “above-consensus bullish view” on them. Price targets for the stocks are $250, and $500, respectively, not far off the levels where they closed Tuesday.
