Getting someone else to do your homework

VT Tyndall Global Select Fund

Getting someone else to do your homework.

A couple of years back the market was caught up in the hype around crypto currencies to the extent that we saw companies such as Long Island Iced Tea Corp renaming themselves to sound as though they were involved in blockchain when in fact they had little or nothing to do with it; Long Island became Long Blockchain Corp; many of these concepts, however, fail to be enduring in nature.

Now it would seem that every company wants to espouse its proficiency in AI with management teams eager to explain how they have been investing in it for many years. What is becoming clear however is that there will be clear winners and losers as AI becomes more mainstream and this may well turn out to be a sink or swim moment for many market participants.

Although AI has only recently captured investors’ imaginations, those at the forefront of the field started investing significantly in the concept many years ago. Microsoft’s announcement in January of a further £10bn investment in Open AI, the firm behind ChatGPT, adding to the $1bn it invested as far back as 2019 and an additional $2bn in 2021, kick started the hype. Prior to this announcement and the release of the product for everyday use, Google was always believed to be in the driving seat - however their knee-jerk reaction to Microsoft’s presentation of showcasing their competitor, Bard, backfired as incorrect answers about the James Web Telescope appeared on the first demonstration via Twitter.

Google Cloud Platform has long espoused that AI was the key differentiating factor between their offering and that of Microsoft’s Azure and Amazon Web Services. While it is true that Google has invested heavily in AI, if employee numbers are anything to go by, Amazon, who has kept tight lipped about its proficiency has out invested all its major cloud peers by a significant amount, and all the cloud hosting players from IBM to Microsoft are informing their clients how they have integrated AI into their offerings and to what extent this is going to continue.

Last week Google relaunched its Bard offering, with much greater success and informed developers that it is already embodied in Gmail and a partnership with SAP for AI powered analysis. Meanwhile Palantir Technologies announced that its AI platform would enter the market later this year and that demand was “without precedent”; both companies saw their share prices spike upwards in the days that followed.

The announcement from Palantir was particularly interesting as it primarily works with governments and corporations with sensitive data and networks, suggesting that some of the concerns over AI security are being overcome. However we expect that regulation will be forthcoming given that more malign parties are likely to look to piggyback on AI for new and more sophisticated ways to accessing data and systems.

The importance of having a credible answer to the arrival of AI in the mainstream is best embodied by the example of Google after its embarrassing initial launch of Bard. In the weeks that followed, Samsung announced that it was exploring using Microsoft’s Bing with its ChatGPT functionality as its primary search engine on its telephones, and given this, investors should look at the likely winners and losers should this type of disruption permeate further.

Should Apple choose to follow Samsung and look at using Bing rather than Google as its primary search engine for iOS the impact is likely to more disruptive to the status quo. Microsoft has signalled its intention to use AI to take market share in digital advertising. It comments that it sees every one-point share gain in search advertising represents a $2bn revenue opportunity for its advertising business; suddenly the $10bn investment doesn’t seem so outrageous. Google’s revenues from iOS are estimated by Barclays to be in the region of $85 billion, with gross profits of around $60 billion, and given their dominance, it is easy to see where Microsoft has set its target.

Diving into the UK competition and Markets data, one can find that despite its dominance, 85% of Googles revenues come from the top 5%-10% of advertisers (just 15k companies). This picture is likely to be similar in the US, so the number of clients that would have to switch to primarily using Bing as their source for marketing dollars is relatively small to have a meaningful impact on both companies. While these two battle it out, ironically it is Apple who is likely to end up as the big beneficiary as it can use the increased competition to drive up the traffic acquisition costs (TAC) charged to Google. A 5% increase in the TAC rate would reduce Google’s operating income by 3% at no cost to Apple which already receives more than a 40% TAC rate. Google has would have little option but to bend to Apple’s demand given the risk of Microsoft being prepared to pay more to drive scale and profitability to Bing.

The ramifications of AI, however, reach further than just the major cloud companies, and while almost every company is now talking about AI, there are definite winners and losers from this new arms race - investors are rapidly looking for the second derivative beneficiaries and those most exposed.

The semiconductor chip maker Nvidia has led the way, widely seen as the primary beneficiary of the extra computing power needed. Microsoft has announced that it will partner with Advanced Micro Devices to develop AI chips, but security companies such as Palo Alto and many more have ridden this wave.

The punishment for not having a viable solution or being seen as having a business model that is under threat by the solutions offered by AI tools is also very apparent.

The online education company Chegg will be by no means the last to fall foul of this trap as students turn to chatbots for answers rather than subscribing to Chegg’s study services and advice, but became the harbinger of how investors are likely to react if you don’t have a answer to the problem. For investors, identifying and avoiding those companies that do not have the ability to adapt and embrace the change is almost as important as finding those which are the primary beneficiaries.

We started this article pointing out that many products have their moment in the sun and then fade as investors move onto the next big thing, however, we would argue that AI is a more long-lasting change and will simply become more and more embedded in everyday life as it develops. Given that even ChatGPT is already two years out of date as it only uses public data prior to 2021, there is plenty of room for development to come and despite the movement in share prices to date, only time will tell whether we are only just on the cusp of a new mega trend. If Bill Gates is to be believed artificial intelligence is a revolutionary as mobile telephones and the internet.

18th May 2023
Read time : 8  mins

This content is intended for professional clients only.

Data source (unless otherwise stated): Bloomberg
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