Microsoft needs a better seat at OpenAI’s table

Microsoft CEO Satya Nadella
Microsoft CEO Satya Nadella

Summary

The leadership crisis exposed Microsoft’s reliance on the AI startup, showing a need for a greater role.

Microsoft played a weak hand rather well in the drama that engulfed OpenAI last week. But the tech giant now has a complicated task ahead: It needs to solidify its relationship with the high-profile startup while also showing it can chart its own course in the vital field of artificial intelligence.

Wall Street has cheered Microsoft CEO Satya Nadella’s handling of the situation, which began with the surprise firing of OpenAI Chief Executive Sam Altman by the company’s board of directors late on Friday, Nov. 17, and concluded with Altman agreeing four days later to return to his role. In the interim, Microsoft announced plans to hire Altman directly, along with any other OpenAI employees who cared to join.

The latter likely played a major role in OpenAI’s board rethinking its decision. Nearly all of the startup’s 770 employees threatened to quit if Altman wasn’t restored to his position. Microsoft’s stock price has risen more than 2% since its Nov. 17 close, adding to a run that has boosted the company’s market value by more than $1 trillion this year.

“We believe Microsoft emerges in a similar-to-better position relative to a week ago," RBC Capital analyst Rishi Jaluria wrote in a note following OpenAI’s announcement of Altman’s return.

Still, the drama exposed a weak point in the AI strategy that has helped Microsoft’s stock outperform most of its major tech peers recently. The close partnership with OpenAI has given Microsoft a leg up in the race over generative artificial intelligence. Microsoft solidified that relationship with a $10 billion investment in the startup in January, two months after the high-profile launch of OpenAI’s ChatGPT chatbot.

That investment gave Microsoft a 49% ownership stake in OpenAI but no board seat or any actual power because of the startup’s unusual governance structure. That still cost Microsoft more than it has spent in all but three of the 245 acquisition deals it has made over the last three decades, according to data from FactSet.

The fact that Microsoft was willing to lay out potentially billions more to bring top-shelf AI talent in house further drove the point home that the company needs for OpenAI to survive in some form or another.

And even that plan had its drawbacks. Goldman Sachs analyst Kash Rangan wrote to clients last week that duplicating OpenAI “would be a time-consuming and demanding task, notwithstanding IP consideration." Mark Moerdler of Bernstein noted that such a transition could also produce a “gap in innovation" that would allow rivals such as Google and Amazon “to catch up technologically and possibly in market perception."

As such, Altman’s return to OpenAI is the best outcome for Microsoft. And the restructuring of OpenAI’s board, which now includes former Treasury Secretary Larry Summers and experienced software vet Bret Taylor, is another plus. OpenAI reportedly is planning to further expand its board. Microsoft now has too much riding on the company just to watch from the sidelines. Bernstein’s Moerdler predicted last week that Microsoft and other OpenAI investors were “likely to push for board seats and more of a say to protect their investments" in the event that Altman would return.

But Microsoft might also want to start hedging the risk of its perceived reliance on OpenAI. The company is already selling generative AI tools and services such as its Copilot digital assistant to big corporate customers, who value stability in their major technology investments.

“A loss of customer confidence in OpenAI is a net negative for Microsoft, there is no way to sugar-coat that," wrote Karl Keirstead of UBS in a note prior to the news of Altman’s return. Wall Street already has high expectations; revenue from the Microsoft Cloud segment is expected to average 20% growth over the next two years, trumping the 17% growth Amazon’s AWS cloud business is expected to average in that time, according to consensus estimates from Visible Alpha.

Building up more of its own AI technology won’t be cheap. Microsoft is already spending more than $27 billion annually on research and development—a new company record. But the company lost nearly that much in market value in just minutes after OpenAI announced the canning of its popular CEO. Microsoft might find that controlling more of its own destiny is cheaper in the long run.

Write to Dan Gallagher at dan.gallagher@wsj.com

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