The news that Microsoft (NASDAQ:MSFT) will spend $10 billion to acquire a 49% stake in ChatGPT is viewed negatively by Alphabet (NASDAQ:GOOGL). The AI chatbot service does not pose as much of a threat to Google as many believe. My investment thesis remains extremely bullish on Google stock, which is trading near $90, due to concerns that an AI chatbot will disrupt their main business.
Microsoft Makes a Significant Investment
The software giant is planning to invest up to $10 billion in OpenAI to acquire the promising AI chatbot technology. The deal is intriguing in that Microsoft appears willing to pay a $29 billion valuation for only 49% of the business, even though the tech giant will receive 75% of profits until the investment is repaid.
The agreement is unusual in that Microsoft will not control the business but will maintain the AI technology on their cloud services. While many analysts believe Google search is in grave danger, many technology leaders continue to issue tweets like the one below, emphasizing the severe limitations of AI chat services.
When ChatGPT can’t even provide the current leader of Twitter and the timing of the CEO change, Google search appears to be safe. Other queries indicate that the AI chatbot cannot report the World Cup winner because it was trained using older data.
Because the service cannot search the web for answers, ChatGPT is severely limited in its current form. Google has its own AI voice services that can be integrated into Google search, but OpenAI would need to provide a search function that can search the internet for answers to replace what the search giant currently does.
According to most statistical measures, Google controls nearly 90% of the search engine market share in the United States. Bing controls a small portion of the market, estimated by Statcounter to be less than 7%.
Alphabet leverages its dominant market share to build a search business with nearly $40 billion in quarterly revenue. Google Network ads contribute another $8 billion in quarterly revenue, which, combined with YouTube ads, results in a business with huge operating margins of 40% in Q3’21.
Last quarter’s margins fell due to misaligned spending as the economy weakened. Furthermore, the Google Search business will likely have much higher margins than the other business units included in the Google Services figures, such as YouTube ads.
Naturally, Microsoft wants a larger share of this high-margin business, and ChatGPT is seen as a way to get more business. So much so that Google has held internal code read meetings to ensure ChatGPT does not steal the search market’s golden goose.
While some see the AI chatbot service as a threat to Google search, even OpenAI’s founding CEO does not believe the service is ready for real-world use. Sam Altman freely admitted that ChatGPT creates a false sense of greatness.
Because the AI chatbot appears to be good at writing and fixing code, the service may have a bright future working with developers rather than replacing Google search. According to The Information, Microsoft plans to launch a version of the Bing search engine with the AI powering ChatGPT by the end of March. The timeline is highly aggressive, given that the service cannot correctly answer a question about Twitter’s CEO, and Sam Altman suggests that the AI produces output with questionable veracity.
CNet cites a number of other AI chatbots and even search engines that use similar GPT-3 technology. Not to mention, Google already has its own language model called LaMDA, which has the potential to be integrated into Google search. The original message from Google was that this natural language model, like the ChatGPT, was not ready for prime time because it had not been fully trained.
A Massive Rebound Is On The Way
Apple (NASDAQ:AAPL) and Microsoft had the highest forward P/E multiples as they exited the early November lows. These stocks have, predictably, struggled to gain traction this year. Alphabet is more similar to Meta Platforms (NASDAQ:META), but the social media stock has already recovered more than 54% from its lows. Alphabet has barely risen 10% in the market rebound, while the Invesco QQQ ETF has risen 8%.
The point is that Alphabet’s fear of ChatGPT has prevented it from rallying like Meta. According to our estimates, the search giant has the potential to generate up to $10 in EPS after improving efficiency. The 15% layoff at Verily is the latest indication that CEO Sundar Pichai is serious about his high-level target of 20% efficiency improvements.
The most significant risk to a considerable stock rebound is that Google is forced to launch a competing AI chatbot integrated into search. Because of the high costs, Microsoft may invest $10 billion in OpenAI. Any aggressive competition on this front could squeeze margins just as the market expects Google to become 20% more efficient, as promised by the CEO.
Google Stock: Bottom Line
The key investor takeaway is that Google stock remains overpriced, despite the large EPS potential from efficiency gains. So far, the ChatGPT threat has been greatly exaggerated.
Featured Image: Unsplash @ Arkan Perdana