A top-performing fund manager has been selling off Microsoft stock, citing concerns about the tech giant’s future profitability in the face of advancements in artificial intelligence. Stephen Yiu, chief investment officer at the Blue Whale Growth Fund , revealed his fund has been reducing its Microsoft position over the past six months. The Blue Whale Growth Fund held Microsoft since its inception until August this year. The fund is up 16.6% this year. In 2023, the fund returned 30.7%, significantly outperforming its benchmark and the S & P 500, which was up 26%. Yiu’s decision stems from his belief that Microsoft’s business model is about to change significantly in light of the rise of generative AI. MSFT 1Y line “The business model of Microsoft is going to change dramatically on the back of generative AI,” Yiu told CNBC Pro at the Quality-Growth Investor Conference in London earlier this month. Microsoft has been leading the charge in generative AI adoption. The company has invested billions into ChatGPT owner OpenAI , which has been at the forefront of AI research and development. Microsoft has also aggressively integrated AI into its own services, such as the developer platform GitHub and productivity software suite Office 365. The fund manager’s concerns center on Microsoft’s new AI-powered product, Office 365 Copilot , which the company is pricing at an additional $30 per user per month on top of its standard Office 365 subscription. While this may seem like a revenue boost, Yiu suggested that it could actually lead to a decline in Microsoft’s profit margins. Microsoft has reported rising profit margins over the past seven years in its Productivity & Business Processes division, which includes Office 365 services. Operating profit margin rose from 36% in the year ending June 2018 to 52.2% this year, according to FactSet data. The division has also consistently grown by a double-digit percentage year on year, from $35.9 billion in 2018 to $77 billion this year. Yiu believes that while Microsoft might make a higher gross profit, the profit margins on the new AI-powered services are likely to be significantly lower than those on traditional software subscriptions. “The quality of Microsoft [earnings] in the next five to 10 years is going to come down from where it has been,” Yiu explained. The crux of the issue lies in the increased costs associated with providing AI services, according to the outperforming fund manager. Unlike traditional software, AI requires substantial computing power and investment in hardware infrastructure. This shift is primarily due to the need for expensive AI chips, such as graphics processing units, either purchased from companies like Nvidia or developed in-house, to power the AI features. Nvidia’s chips, while readily available, allows the Silicon Valley company to capture much of the profit from generative AI services instead. While in-house AI chips may lead to cost savings for Microsoft in the future, they are costing the company significantly more in the near term. Nvidia is currently one of Blue Whale Growth Fund’s top 10 holdings . Additionally, the constant need for retraining and updating AI models means those costs are ongoing rather than one-time investments. “They need to forever invest into the hardware or the AI infrastructure to give us [AI] capability. And it’s forever demanding because of the [AI] learning and retraining. The feedback [loop] will never stop,” Yiu emphasized. While Yiu acknowledges that Microsoft’s absolute dollar profits are likely to grow, he believes the company’s return on invested capital will decline. However, the consensus expectation among Wall Street analysts is that Microsoft will rise by 20% over the next 12 months, according to FactSet figures.
