GP Bullhound's weekly review of the latest news in public markets.

This week's update covers more company results (still all about AI), including Microsoft, Alphabet and AMD.

Market: somewhat mixed this week - the rate cut debate in the US rumbles on…?

Portfolio: the busiest week for reporting in the portfolio this week - for us no big surprises. We added to AMD on weakness immediately following results.?

For tech, 2024 is still all about AI, and that’s what dominated conference calls this week. For the AI chip players (AMD reported this week) it’s all about how much supply they can bring on in the short term, and then trying to get our arms around the 2025 opportunity (will there be an air pocket of demand after the strong 2024 or can new AI applications create returns that will enable sustained investment?)

All of Microsoft, Amazon, Meta and Google announced capex spend would increase in 2024 given continued investment in AI infrastructure (chips). And when we think about each of Google, Amazon, Meta and Microsoft - they are all in a position to continue to invest - all have large cash balances and an ability to sustain high levels of investment over time.?

For the cloud providers, AI workloads seem to be more than offsetting any remaining optimisation headwinds. Mirosoft explicitly called out 6 points of its growth being driven by AI demand.? And it’s Microsoft which seems to be benefiting the most (and gaining share) when it comes to new AI workloads. Whether it was genius foresight or just good luck from Microsoft, its partnership with OpenAI has been a clear direct benefit for its cloud business (though clearly not without the risks around governance and dependency that came to the fore last year - more on that below).?

For Google and Meta, it’s difficult to disentangle AI with their core business performance. To the extent that they can apply AI to their very large advertising businesses, they appear to be benefitting from AI (compounded by a strongly rebounding digital advertising market). Both are integrating AI into their advertiser tools to increase ad performance, which should result in higher spend to their platforms and accelerating revenues. Alphabet lets advertisers generate whole ad campaigns through Gemini just by entering your website URL.

Spend which went away as a result of lower performance in a post-ATT world (Apple’s App tracking transparency - which effectively stopped the use of third party cookies used to track users across the web) is back, and some - with AI tools around targeting and optimisation seemingly mitigating that ATT impact for advertisers.?

Onto individual results/newsflow:

Microsoft delivering and early positive comments on Copilot adoption

• Microsoft (owned) - beat on revenue and EPS, with every business unit coming in ahead on expectations.?
• The standout though was clearly Azure growth. Last quarter we commented that Azure growth was standing out within the cloud providers - the first to show an inflection - which we attributed to share gains coming from AI and helped by its relationship with OpenAI. This quarter that strong performance continued, with growth remaining stable at 28% (ahead of consensus and ahead of guidance). Microsoft put the contribution of AI at 6 points (from 3 points last quarter)?
• OpenAI benefits Azure growth in two ways: (1) OpenAI’s API runs on Azure - that means that start ups - who might previously have defaulted to AWS - are now running on Azure - notably this quarter Microsoft commented that a third of its customers are new; (2) ChatGPT (OpenAI’s consumer business) has a revenue share agreement (though we don’t know the exact details) with Azure.?
• Though there were perhaps some signals on the call that Microsoft was trying to distance itself from being too dependent on OpenAI (November’s CEO/Board debacle): “We now have 53,000 Azure AI customers, over one-third are new to Azure over the past 12 months. Our new models of service offering makes it easy for developers to use LLM's from our partners like Cohere, Meta, and Mistral on Azure, without having to manage underlying infrastructure.”
• We’ve said before though that beyond cloud acceleration, the real reason to get excited about Microsoft and AI is around Microsoft 365 Copilot. The positive on the call was that the product was already growing faster than E3 and E5 at the same point in the product life cycle as well as some positive early data on productivity gains (which is clearly key for business adoption - at a $30/per seat/per month rate): “And overall early Copilot for Microsoft 365 users were 29% faster in a series of tasks like searching, writing, and summarizing. Two months in, we have seen faster adoption than either our E3 or E5 suites as enterprises like Dentsu, Honda, Pfizer, all deploy Copilot to their employees. And we are expanding availability to organizations of all sizes.”

• Forward looking commercial bookings were strong - +9% yr/yr, ahead of guidance,? with the commentary “driven by.. growth from large long term Azure contracts” - that bodes well more broadly for the large cap software - we had a similar comment on large deal values from SAP and ServiceNow last week
• Amazon (owned) beat on top and bottom line. The key AWS revenue number grew 13% yr/yr - in line with expectations (and a 1point acceleration vs the 12% last quarter) - another positive for the cloud market. They talk about that acceleration continuing, with an end of optimisation as well as strength in ongoing customer AI deployments. And - like Microsoft - strength in larger deal volume: “existing customers are renewing larger commitments over longer periods and migrations are growing. 2023 also was a very significant year of delivery and customer trial for generative AI or Gen AI in AWS.”

• Positive for AWS too is the blowout operating income - $7.2bn in the quarter, 30% operating margin. For context the Cloud business will earn much more than double the core North America retail business this year.
• The other standout continues to be Amazon's advertising business (which we assume is also VERY profitable) - $15bn (in the quarter) growing 26%.

Portfolio view: Microsoft continues to execute phenomenally well, as well as being pretty perfectly positioned from an AI product perspective in both its cloud and core software businesses. It remains a top 3 position in the portfolio. Cloud stabilisation should also be viewed positively for Snowflake/Datadog (owned) - though we acknowledge that they may be later/further downstream beneficiaries of AI workloads and could still be impacted by any ongoing optimisation.?

Digital advertising firmly out of post-COVID/ATT slump

• Alphabet (owned) reported solid headline results, but the wrinkle came in the search growth, which - while accelerating again from last quarter - fell slightly short of expectations and gave way to the ongoing debate around whether AI will start to disrupt Google’s core business.?
• The numbers were by no means a disaster - both search and YouTube growth rates are improving - Search +13% yr/yr from 11% last quarter, YouTube even better acceleration to 16% growth from 12.5% last quarter. As we said above, that might well be helped by the AI products Google has put in place for its advertising customers - effectively enabling better targeting and enabling them to invest more at a higher ROI.?
• BUT the criticism of Alphabet is (1) it does a relatively poor job of answering questions around search disruption (are search queries declining as people use ChatGPT or alternative AI products?) and (2) disentangling what incremental revenue opportunity will come from AI is quite hard to do. (3) comments around growth on a larger revenue base is new rhetoric we should keep an eye on
• The positive: Google’s Cloud business, which disappointed last quarter, accelerated back to 26% growth (from 22% last Q) - it’s not clear whether they’re seeing the same benefit of AI as Microsoft, or an end to optimisation, or both - but good news.
• Meta (not owned) beat on revs and EPS.? Remember the wrinkle on the last set of results were the comments on “softer ad spend” - it looks like that weakness didn’t follow through - revenues growing an impressive 25% (vs 19% guide) and guiding Q1 to sustain at that 25% growth rate.?

• So digital advertising is back - with Meta capturing the best of the recovery. As we noted above, there’s a lot that would suggest that both Meta and Google (but Meta better?) are benefiting from AI being able to effectively deliver better ad performance for its advertisers, in particular mitigating the impact of ATT.?

• Meta are also declaring a dividend (the first ever) and a share buyback - the cost pivot being compounded by “shareholder friendly” capital allocation… though not abandoning Reality Labs - their guidance is for the losses to “increase meaningfully” (again)..?
• One potential wrinkle is the continued contribution of China-based advertisers (PDD, Temu, Shein et al) - which represented 10% of overall revenue and contributed 5 percentage points to total worldwide revenue growth. That’s a significant amount and the risk is clearly around the sustainability of those businesses and the sustainability of spend for Meta.?

Portfolio view: We own Google, where, taking a step back, the most important thing by far is Google’s ad business resilience. It’s still one of the highest returning businesses in tech and it’s back to double digit growth (and it was only 12 months ago the market was playing out scenarios that all of that search revenue was going away…)

We don’t own Meta, given competitive pressures in the digital ad space, though we do recognise that it seems to be capturing the best of the ad spend recovery.?

Capex - big 4 capex spenders all reporting Microsoft, Alphabet, Meta and Amazon?

• And of course - we can’t not talk about capex... all players guiding capex higher in 2024, all commenting on a continued build out of AI infrastructure.?
• Alphabet: “In 2024, we expect investment in CapEx will be notably larger than in 2023.”
• Microsoft: “We expect capital expenditures to increase materially on a sequential basis, driven by investments in our cloud and AI infrastructure”
• Amazon capex obviously has a lot of moving parts (warehouses as well as its cloud business) - it came in at $15bn for the quarter ($53bn for the full year). The colour on the call was that the cloud business capex reached 60% (high vs history) and that AI infastructure spend would drive capex higher in 2024:?
• “A lot of the mix of investment in 2023 was tied to infrastructure, mostly supporting AWS but also supporting our core Amazon businesses was about 60% of our spend. So it reached a very high percentage. We anticipate those trends continuing into 2024. CapEx will go up in 2024. I'm not giving a number today, but we do -- we're still working through plans for the year, but we do expect CapEx to rise as we add capacity in AWS for region expansions, but primarily the work we're doing with generative AI projects.”
• Meta are now guiding 2024 capex of $30-37bn (it was $30-35bn previously) “driven by investments in servers, including both AI and non-AI hardware, and data centers as we ramp up construction on sites with our previously announced new data center architecture. Our updated outlook reflects our evolving understanding of our artificial intelligence (AI) capacity demands as we anticipate what we may need for the next generations of foundational research and product development. While we are not providing guidance for years beyond 2024, we expect our ambitious long-term AI research and product development efforts will require growing infrastructure investments beyond this year.”

Portfolio view: In the portfolio we benefit from the capex spend on servers and network infrastructure through the semiconductor content - the servers that are used in training and inference have a huge amount more semiconductor content in them and are multiples the cost of standard enterprise servers: More and faster CPUs and GPUs through AMD and Nvidia, both of whom make their chips at TSMC, and further down the chain benefitting the semi cap equipment companies which are all needed to make these leading chips.

AMD and the $400bn AI chip TAM?

• AMD (owned) - reported an “ok” quarter but much more important were the comments it made around the mix/ramp of the MI300X GPU (the Nvidia alternative) and the broader comments around AI chip demand.?
• Importantly, it’s increasing 2024 AI chip revenue (the MI300X which competes directly with Nvidia) to "exceeding $3,5bn" from $2bn
• We've said before we think that $3.5bn can be more like $4-5bn but we expect we'll see upgrades of that number through the year and it sounds like AMD have secured access to more capacity when that demand comes through.??

• Remember that's a number that's coming from nothing -? We’ve said before that there are lots of reasons why AI players will not want to be tied into Nvidia - everyone is motivated to look for a credible alternative to Nvidia - particularly in the bigger inference market - so as not to be tied into one very powerful supplier. More importantly, Nvidia are currently supply constrained - and so there are many customers struggling to get their hands on Nvidia H100/H200 chips. AMD is the most credible alternative here.

• In December, AMD outlined a new $400bn 2027 TAM for AI. It’s the sort of increase that would usually be scoffed at, were it not for the fact that we know that AMD and Nvidia both have a tremendous amount of visibility driven by the current supply constraints across the industry. ?
• Much of the call was spent going through AMD’s confidence and visibility around this $400bn number and really quite robustly defending it, as well as giving colour on the broader market.?
• Within that $400bn figure are accelerators and ASICs (and it includes the broader memory TAM) - Lisa Su said she expects inferencing to be a larger market than training (we agree), and - something we’ve commented on previously - for GPUs to remain the lions share of compute (vs ASICs)
• There were lots of references to “multi generational roadmaps” - and we’ve talked before about Nvidia’s roadmap, with its B100 and X100:?
• “One of the things I will note about the AI accelerator market is the demand for compute is so high that we are seeing sort of an acceleration of the roadmap generations here and we are similarly planning acceleration of our roadmap. I would say that we'll talk more about the overall roadmap beyond MI300 as we get into later this year. But you can be assured that we're working very closely with our customers to have a very competitive roadmap for both training and inference that will come out over the next couple of years.”
• That likely means ASP will be a meaningful driver of that TAM - and both AMD/Nvidia revenue and margins. Pricing power in a two player market is real!

• Elsewhere, PC was better (like Intel), though AMD are probably losing share in the notebook market. Importantly though it is still clear that AMD’s march on traditional server market share continues (AMD’s datacentre business continuing to outperform).?
• Relatedly, Super Micro reported its results (having issued a positive profit warning earlier in January) - it beat even the raised guide and issued its Match quarter guidance 25% ahead of where consensus was. Management commentary was that it continues to see demand for AI much stronger than supply, though helpfully that supply is improving- it talked to both AMD’s MI300 product ramping and Nvidia’s L40S.?

Portfolio view: we own both AMD and Nvidia and continue to see those as capturing the most immediate downstream AI opportunity in the market.?

Memory and the HBM opportunity - positive for semicap?

• This week Samsung reported it’s full results (we had the preliminary numbers earlier in the month) - DRAM bit growth reached +35% qtr/qtr - significantly above the initial guidance of low teens, with better inventory environment, content growth in PC, strong Chinese smartphone demand and strong AI server demand all helping.?
• ASP also increased 13% qtr/qtr, and the DRAM business turned profitable in Q4 - the first time since Q4 2022.?
• We’ve talked lots about the importance of memory in AI. HBM (High Bandwidth Memory - which is required in AI given higher processing speeds) die sizes are twice the size of equivalent capacity - that’s important because higher die sizes naturally limit industry supply growth, and ultimately requires more semicap equipment.
• Samsung spoke explicitly about this and opened the door to supply undershooting demand this year:
• “This year, CapEx is expected to recover overall in the industry somewhat, but most will be focused on HBM and the non-HBM production bit growth is likely to be even more limited. Also, HBM has larger chip size versus the existing DDR products and also needs a buffer chip on the bottom, which are all additional production constraints, further limiting bit growth achievable for a given CapEx. Under such limited production, if the market suddenly sees improvements, it is possible that demand -- that supply may be below demand around certain advanced node products. We have maintained CapEx last year, despite profitability challenges and have increased our supply capabilities across not only HBM, but also other products as well. And it is time for us to now use that supply competitiveness we have preemptively prepared to respond stably to customer demand going forward.?

Portfolio view: we don’t own memory players (they don’t meet our high return on invested capital requirements) but we will benefit from increased pricing and increased die sizes through our semicap exposure (in particular LAM which is overexposed to memory).?

Smartphone hopes of an AI driven replacement cycle

• Apple (small/underweight position) headline results were fine, but Q1 guidance was weak, implying iPhone revenue down ~10%, and some of the details (China especially) keep some key question marks on the forward looking growth rates.?
• China sales were down 13%, which Apple put down to FX but which even excluding RMB weakness were down mid single digit. There’s no escaping Huawei is impacting them and Huawei are taking significant taking share (from a standing start with its Mate 60 Pro), with more models launching – its foldable phone is rumoured to have a 10m unit target this year. It’s worth remembering that Huawei used to have 16% smartphone market share in China, which declined to ~2% by 2022 (after the US blacklist..) – so Huawei certainly represents a credible threat to Apple volumes in China.?
• Services revenues were better, that line ’s hugely outperforming the rest of the business - 11% growth - That benefits from Apple’s ongoing price rises, advertising strength (a big part of this number is Apple’s distribution agreement with Google which has clearly seen some scrutiny with ongoing DoJ trial), app store, payments..?
• Staying on smartphone, the key take in Skyworks, Qualcomm and Qorvo’s results for us (none of them are owned) was that all spoke to a recovery in the Android smartphone market with smartphone units expected to be up low single digits in 2024.?
• Qualcomm offering some particularly helpful commentary around China demand and around inventory clearing (also reflected in Qorvo’s comments on channel inventory normalising): “As we have said previously, as we entered fiscal ‘24, our view was that Android channel inventory had largely normalized. And so as we go through the year, we typically see normal bill bleed cycle around handset launches. So that’s kind of the phase we are in from our perspective.
• In the first quarter, what we saw was higher demand due to the acceleration of Android flagship launches with our new chip, Snapdragon 8 Gen 3. And we saw very strong demand across all the major Android OEMs. And so happy, of course, with that traction and that momentum carries over to the second quarter as well. And that’s what you’re seeing both in our results and our guide going forward.
• In terms of your comment on Huawei, really what we’ve seen since Huawei 5G launch is that the premium tier TAM in China has expanded. And so we’re continuing to see strong demand from our customers post that launch.”
• Samsung too spoke to the potential for AI to start driving a replacement cycle of end devices: For the smartphone market, the introduction of on-device AI expected -- expect to attract customers’ desire to replace smartphones. The market has declined steadily over the past few years due to the increased replacement cycle, and with this on-device AI, we’ll flexibly respond to -- respond by accounting for the possibility of changes in demand and inventory from Q1.
• UMC (TSMC’s “little brother” foundry) also spoke to stabilising consumer demand across PC and smartphone, while its industrial and auto business is seeing an ongoing correction - though as we’ve said before, we think what UMC (and TSMC - who made the same comments last week) might be seeing is just more insourcing of auto volume to IDMs.?

Portfolio view: Despite the market bottoming, we still don’t like specific exposure to the PC and Android markets (unlike auto and AI, the content story in both is over, and both are fairly fully penetrated unit-wise). The Android market is still especially tough to call for US component suppliers given no one is supplying into Huawei (since it’s on the restricted list) so, while players like Qualcomm are arguing that it will have no impact on their sales, we think that’s surely unlikely, with Huawei’s Nova 12 (mid tier) launch late last year also potentially disrupting market shares further.?

Apple’s forward looking growth rate remains in question and it’s also one of our most expensive names, trading on ~30x 2024 earnings. So why do we own any of it? It can still be helpful in a portfolio construction context - there are times in the cycle where it’s very defensive (a good hiding place) - we often talk about it more like a consumer staple a-la Unilever (is Apple the one technology company that your grandchildren will still be using in 50 years?).?

At this particular point in time though there are, we think, lots better opportunities to put capital in, which is why it’s currently one of the smallest positions in the portfolio (and is significantly smaller than the index weight).

For enquiries, please contact:

• Inge Heydorn, Partner, at [email protected]
• Jenny Hardy, Portfolio Manager, at [email protected]
• Nejla-Selma Salkovic, Analyst, at [email protected]

About GP Bullhound GP Bullhound is a leading technology advisory and investment firm, providing transaction advice and capital to the world’s best entrepreneurs and founders. Founded in 1999 in London and Menlo Park, the firm today has 14 offices spanning Europe, the US and Asia.