<div id="readability-page-1">In 2019, Microsoft (MSFT -0.68%) invested its first $1 billion in OpenAI, a San Francisco-based start-up focused on artificial intelligence (AI). At the time, Microsoft worried it had fallen &#34;multiple years behind the competition in terms of machine learning,&#34; according to messages between Chief Technology Officer Kevin Scott, CEO Satya Nadella, and co-founder Bill Gates. In particular, Microsoft was worried about recent technological advancements made by Alphabet's Google, a long-standing leader in AI research through its DeepMind subsidiary. Microsoft pounced on what it saw as a chance to level the playing field by investing in OpenAI. The companies have since extended their partnership such that Microsoft's total funding commitment stands at $13 billion. In late 2022, OpenAI introduced ChatGPT, which quickly became the fastest-growing consumer application in history, reaching 100 million monthly active users in two months. Shortly thereafter, JPMorgan Chase analysts wrote, &#34;We think that Microsoft's investment into OpenAI, which started years ago, could potentially prove to be some of the best money ever spent.&#34; Here's what investors should know. <div><img src="https://imageproxy.pbkrs.com/https://g.foolcdn.com/image//query-b3A9cmVzaXplJnVybD1odHRwczovL2cuZm9vbGNkbi5jb20vZWRpdG9yaWFsL2ltYWdlcy83OTcyNjYvc3RyYXRlZ3ktNi5qcGcmdz03MDA?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" width="700" height="467" original-src="https://imageproxy.pbkrs.com/https://g.foolcdn.com/image//query-b3A9cmVzaXplJnVybD1odHRwczovL2cuZm9vbGNkbi5jb20vZWRpdG9yaWFsL2ltYWdlcy83OTcyNjYvc3RyYXRlZ3ktNi5qcGcmdz03MDA"/>Image source: Getty Images. </div> <h2>Why Microsoft's $13 billion investment in OpenAI was brilliant</h2> Microsoft has (or will) benefit in several ways from its partnership with OpenAI. First, as the exclusive provider of cloud computing services to the AI start-up, Azure monetizes all workloads involving OpenAI large language models (LLMs) and applications because they run on its infrastructure. That means Microsoft indirectly earns revenue on products like ChatGPT Enterprise. Second, Microsoft has integrated OpenAI models into its software products and cloud platform. In 2023, it debuted Microsoft 365 Copilot, a generative AI assistant that automates tasks in office applications like Word, PowerPoint, and Excel. Nearly 70% of Fortune 500 companies have already adopted Copilot. Microsoft also debuted Azure OpenAI Service, which lets Azure users build generative AI applications with OpenAI models, helping to draw 60,000 customers to Azure. Third, Microsoft is ultimately entitled to a percentage of OpenAI's profits, as detailed below. The following information comes from The Wall Street Journal. <ul> <li>Phase 1: OpenAI will use its first $194 million in profits to pay back its first investors.</li> <li>Phase 2: OpenAI will split its next $17.3 billion in profits between its first investors and Microsoft, with Microsoft receiving 75% of profits until it has recouped its $13 billion investment.</li> <li>Phase 3: OpenAI will pay 49% of its profits to Microsoft until a predetermined cap is reached. The precise value of the predetermined cap is unknown.</li> <li>Phase 4: Once Microsoft has reached its predetermined return cap, OpenAI will retain all profits from that point forward.</li> </ul> Importantly, Microsoft has not yet fulfilled its $13 billion funding commitment to OpenAI, so those investments are currently a headwind to earnings. For instance, the company recorded a $683 million expense related to its share of OpenAI losses in the first quarter of fiscal 2025 (ended September 2024). CFO Amy Hood expects that figure to expand to $1.5 billion in the second quarter. However, Morgan Stanley analysts believe Microsoft will reach its $13 billion funding cap in fiscal year 2026 (ends June 2026), at which point earnings growth should accelerate. For instance, Microsoft's generally accepted accounting principles (GAAP) net income increased 11% in the most recent quarter, but it would have increased 14% had the $683 million investment in OpenAI been excluded. <h2>Is Microsoft stock a smart investment right now?</h2> To summarize, Microsoft has made total funding commitments of $13 billion to OpenAI over a multiyear period. In exchange, OpenAI relies exclusively on Azure for cloud computing services. Additionally, Microsoft will ultimately recoup its initial investment and will be entitled to 49% of OpenAI's profits until a predetermined return cap is reached. Admittedly, OpenAI is still burning money. In fact, a recent report from The Information suggests the company won't turn a profit until 2029. But Microsoft's investment in OpenAI is still (arguably) some of the best money ever spent. Microsoft effectively paid $13 billion for a 49% profit-share agreement with an AI start-up recently valued at $157 billion! Importantly, Microsoft's bottom-line growth should accelerate once it has completed its funding obligation to OpenAI. Indeed, while Wall Street estimates earnings will increase 9% over the next 12 months, analysts forecast earnings will increase at 14% annually through fiscal 2028, implying a meaningful uptick in growth a few years down the road. Consequently, while the current valuation of 35 times earnings still looks a little expensive, it's not outrageous. Among the 56 analysts who follow Microsoft, 91% rate the stock a buy, and the median price target of $500 per share implies 18% upside from its current share price of $422. Patient investors should feel comfortable buying a small position today. </div>

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Microsoft's $13 billion investment in OpenAI is viewed by Wall Street analysts as potentially one of the best financial decisions ever made. The partnership allows Microsoft to monetize OpenAI's AI models through its Azure cloud services and integrate them into its software products. Although Microsoft has incurred expenses related to OpenAI's losses, analysts predict that once the funding commitment is fulfilled by 2026, earnings growth will accelerate. Currently, 91% of analysts recommend buying Microsoft stock, forecasting an 18% upside from its current price.

- In 2019, Microsoft invested $1 billion in OpenAI to catch up in AI technology, particularly against competitors like Google.  
- The partnership has allowed Microsoft to monetize OpenAI's applications through its Azure cloud services and integrate AI models into its products, with a profit-sharing agreement in place.  
- Although OpenAI is not yet profitable, analysts predict Microsoft's earnings will accelerate after fulfilling its funding commitment, making its investment potentially very lucrative.

Microsoft's $13 Billion Investment in OpenAI May Be "Some of the Best Money Ever Spent," According to Certain Wall Street Analysts