Rothschild Downgrades Microsoft and Amazon Amid Concerns Over Generative AI Economics

Rothschild & Co Redburn has downgraded both Microsoft (MSFT) and Amazon (AMZN) from a "buy" to a "neutral" rating, reflecting a more cautious outlook on the generative artificial intelligence (Gen-AI) sector. Analyst Alex Haissl emphasized that the current investment thesis surrounding Gen-AI is increasingly flawed, stating, "It is time to take a more cautious stance on the hyperscalers and move beyond the industry's reassuring 'trust us — Gen-AI is just like early cloud 1.0' narrative." He highlighted that the underlying economics of Gen-AI are significantly weaker than previously assumed, with capital expenditures (capex) required to generate value being approximately six times higher than those of traditional cloud services.

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Haissl reduced his price target for Microsoft to $500 from $560, indicating a potential downside of about 1% from its recent close. He cited concerns over revenue leakage from Office 365 as third-party models like OpenAI and Anthropic gain traction. For Amazon, the price target remains at $250, suggesting a 7% upside, but Haissl noted limited growth potential for Amazon Web Services (AWS), stating that "AWS has reaccelerated broadly...leaving limited scope for meaningful upside relative to buy-side expectations."

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The downgrades come amid a broader cooling of enthusiasm for tech stocks, particularly those involved in the AI sector. Haissl remarked that the costs associated with developing Gen-AI are not being justified by the revenue it generates. He pointed out that the capital intensity required for Gen-AI development is nearly three times higher than that of early cloud computing, which raises questions about the sustainability of current valuations. The report arrives just before Nvidia's earnings announcement, further intensifying scrutiny on the AI narrative.

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Haissl's analysis challenges the prevailing belief that Gen-AI will replicate the success of cloud computing. He stated, "There is no credible path back to 'Cloud 1.0' economics," suggesting that the market is still pricing in unrealistic outcomes. This misalignment, according to Haissl, underpins the cautious stance taken by Rothschild.

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For Rothschild to adopt a more positive outlook on Microsoft and Amazon, Haissl indicated that both companies would need to demonstrate sustained higher growth and reduced build costs. The downgrades mark a significant shift from years of maintaining an "above-consensus bullish view" on these tech giants, reflecting a growing skepticism about the future profitability of the Gen-AI sector.

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• “It is time to take a more cautious stance on the hyperscalers and move beyond the industry's reassuring 'trust us — Gen-AI is just like early cloud 1.0' narrative, which looks increasingly misplaced,” — Alex Haissl, Analyst at Rothschild & Co Redburn

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• “no credible path back to 'Cloud 1.0' economics,” — Alex Haissl, Analyst at Rothschild & Co Redburn

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• “AWS has reaccelerated broadly as we expected, leaving limited scope for meaningful upside relative to buy-side expectations,” — Alex Haissl, Analyst at Rothschild & Co Redburn

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This analysis underscores a pivotal moment for investors in Microsoft and Amazon as they navigate the evolving landscape of generative AI and its economic implications.

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