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Top Fund Manager Sells Microsoft Stock Amidst AI Profitability Concerns
A leading fund manager, Stephen Yiu, CIO of the high-performing Blue Whale Growth Fund, has made the bold decision to significantly reduce the fund’s holdings in Microsoft. This move, undertaken over the past six months, stems from Yiu’s concerns about the potential impact of artificial intelligence (AI) on Microsoft’s future profitability. Despite Microsoft’s aggressive embrace of AI and its impressive performance in the generative AI space, Yiu argues that the inherent costs and changing business model may ultimately dampen the tech giant’s return on investment in the long run, a stark contrast to the overwhelmingly positive Wall Street predictions for the company.
Key Takeaways: Why Yiu is Betting Against Microsoft (For Now)
- High-performing fund manager, Stephen Yiu, is reducing his Microsoft holdings due to concerns about future profitability.
- Yiu believes Microsoft’s business model will change dramatically due to increased costs associated with generative AI.
- The introduction of AI-powered features, such as Office 365 Copilot, may lead to lower profit margins despite increased revenue.
- High capital expenditure needed for AI infrastructure (hardware and constant model retraining) eats into profitability.
- Yiu suggests that while absolute profits may continue to grow, return on invested capital (ROIC) will decline.
The AI-Driven Shift in Microsoft’s Landscape
Microsoft’s substantial investment in OpenAI and the integration of AI into its services, including GitHub and Office 365, has positioned the company as a leader in generative AI. However, Yiu’s concerns are not about Microsoft’s leadership position, but rather the economics of this new paradigm. He points to the introduction of Office 365 Copilot, a significant addition to the Office 365 suite but one that carries a considerable monthly cost per user. While this new offering will likely boost revenue, Yiu argues the profit margins will be significantly lower than those achieved with traditional software subscriptions. This is a critical shift for a company that has demonstrated strong and rising profit margins over the past seven years in its Productivity & Business Processes division, which includes Office 365.
The Numbers Don’t Lie (But They May Be Changing):
FactSet data reveals that Microsoft’s operating profit margin in its Productivity & Business Processes division has risen from 36% in 2018 to 52.2% in 2024. Revenue growth has also been substantial, growing from $35.9 billion in 2018 to $77 billion in 2024. Yiu’s concern is that these impressive numbers may not be sustainable. The higher upfront costs of integrating AI and maintaining its efficacy represent a significant challenge to these margins. He believes that, while Microsoft may see a short-term increase in absolute dollar profits, “the quality of Microsoft earnings in the next five to 10 years is going to come down from where it has been,” he explained.
The High Cost of AI: Hardware and Beyond
The heart of Yiu’s argument lies in the substantial costs associated with providing AI services. Unlike traditional software licensing, AI requires significant investments in hardware infrastructure, particularly high-powered computing resources. This translates to a reliance on expensive AI chips, such as Graphics Processing Units (GPUs), predominantly manufactured by companies like Nvidia. While Microsoft could develop their own chips, that represents a considerable short-term cost. Currently Nvidia’s is one of Blue Whale Growth Fund’s top 10 holdings representing a positive counterbalance to the Microsoft sell-off.
The Ongoing Investment in AI: A Constant Drain?
Yiu further emphasizes the ongoing nature of these costs. The continuous need to retrain and update AI models to maintain performance and accuracy means expenditures are not a one-time investment, but rather an ongoing requirement. “They need to forever invest into the hardware or the AI infrastructure to give us [AI] capability,” Yiu stated. “And it’s forever demanding because of the [AI] learning and retraining. The feedback [loop] will never stop.”
Wall Street’s Optimism vs. Yiu’s Cautious Approach
Despite Yiu’s concerns, the consensus among Wall Street analysts remains bullish on Microsoft. FactSet data suggests a consensus expectation of a 20% increase in Microsoft’s share price over the next 12 months. This stark contrast highlights the divergence in perspectives between a seasoned fund manager with a demonstrably successful track record and the broader market sentiment. Yiu’s strategy doesn’t necessarily represent a bet *against* Microsoft’s long-term success, but rather a cautious assessment of the short-to-medium term impact of the ongoing transition to an AI-powered enterprise.
The Blue Whale Growth Fund’s Track Record:
It’s important to note the Blue Whale Growth Fund’s exceptional performance. The fund boasts a 16.6% return year-to-date in 2024 and a remarkable 30.7% return in 2023, significantly outperforming its benchmark and the S&P 500. This success underscores the expertise and insight of Yiu and his team, adding weight to their concerns about Microsoft’s evolving profit structure. His actions suggest the market may currently be overlooking the long-term implications of the considerable financial resources required to compete at the highest levels within the burgeoning generative AI space.
Conclusion: A Calculated Risk
Stephen Yiu’s decision to reduce the Blue Whale Growth Fund’s Microsoft position reflects a calculated risk based on a deep understanding of the evolving landscape of artificial intelligence. While Microsoft’s absolute dollar profits are likely to continue growing, Yiu’s concern is that the return on invested capital (ROIC) may decline, making the investment less attractive than other high growth companies less reliant on capital expenditure to maintain their competitive advantage. Whether the market will eventually reflect Yiu’s perspective remains to be seen, but his concerns serve as a compelling reminder of the complexities and potential hidden costs involved in the rapid advancement of artificial intelligence. The long-term impact of AI on tech valuations is still unfolding, a situation that demands careful consideration from investors and business leaders alike.
