A Few Thoughts on Alphabet and AI

“The age of AI is filled with opportunities and responsibilities.”

Bill Gates, co-founder of Microsoft

Nearly halfway through 2023 now, uncertainty remains the defining characteristic of the contemporary economy.

As of this writing, political leaders in the U.S. are taking their debt limit negotiations down to the wire, and the ultimate outcome of those talks remains anyone’s guess. Historically, since the 1917 creation of the debt limit (the maximum amount of debt the U.S. government can assume under the law), raising the debt ceiling has largely been a procedural issue. It's unfortunate that we live in a different environment today, wherein a toxic political culture means that, to the extent parties can weaponize the process of government for political gain, they will do so. The result is a lot of unnecessary insecurity and potential downside for the business class, investors, and citizens.

That said, we continue to shy away from mixing the political with the financial, and the debt ceiling deliberations have had relatively minimal impact on overarching strategy at GDS Investments. Investors have no choice but to operate within a wide range of economic environments, ranging from the very bullish to the very bearish. Just as good companies can operate successfully in a lot of different situations, so too can wise investors – and that’s founded on taking a long-term view and selecting positions that will be able to stand the test of time and weather upheaval in the market.

Additionally, as I have written before, history shows that uncertainty and chaos can serve as crucibles for great opportunity. One area this year of particular unpredictability, interest, and opportunity has been the sudden momentum behind Artificial Intelligence (AI) and emerging AI-powered technology products.

Clearly one of the more striking developments in the tech sector in recent history, AI has been capturing headlines all year and holds truly transformative potential. When Microsoft launched its ChatGPT-powered Bing AI in early February, Microsoft (NASDAQ: MSFT) CEO Satya Nadella said, “It’s a new day for search.”

He’s not wrong, but it may not be Microsoft the reaps the real benefits. In the month following the new Bing AI launch, Microsoft’s market share in desktop search barely budged, rising only from 8.19% to 8.23% (and both are decreases from January).

Instead, the company that stands to gain the most from incorporating AI into its flagship products is Alphabet (NASDAQ: GOOG), already one of our largest positions due to its forward-looking management and product development. Admittedly, Google’s initial AI offering (Google Bard, an AI chatbot like ChatGPT) was rushed to market to undercut Microsoft’s perceived first-mover advantage; and it may have even fumbled that launch, with Bard almost immediately making basic mistakes.

Yet that misstep is an unusual one for the company that owns 85% market share of desktop search, and one that may not be repeated as Google seeks to differentiate its own AI offerings from competitors like ChatGPT. Indeed, in retrospect, Google was likely simply spooked into launching a little prematurely. Google Search remains the front door to the Internet for billions of users, and the company did not achieve its market-leading status by subjecting its users to poor quality experiences. Instead, it has spent years building trust with its user base by persistently prioritizing user experience even at the cost of short-term revenue gains, an attitude that is unlikely to change overall just because they are now developing and implementing new technologies.

A few months on, Google seems to recognize more clearly that it's to their advantage to be responsible with AI from a brand perspective. “Building AI responsibly is the only race that really matters,” Google CEO Sundar Pichai recently wrote in The Financial Times.

One thing is for certain: there are going to be real productivity gains connected with AI, especially to the extent that AI will be increasingly built into a lot of product offerings used by millions or billions of people worldwide. From Google Docs to Search to Photos, we expect virtually all of Alphabet’s product offerings to feature greater capabilities as they are increasingly underpinned by advanced AI. Google’s annual I/O developer conference in mid-May heavily featured the current and planned incorporation of AI technologies into its full portfolio of products. As MIT Technology Review put it afterwards, “That wasn’t Google I/O; it was Google AI.”

The market clearly approves. Google’s stock price rose 6.5% after the conference and has continued to rise overall since. At the time of this writing, the stock price remains over 13% higher than its pre-conference price of $109.82 on May 9.

We do wonder if the stock value would not have increased even more, were it not for persistent fears around AI. A few days after Google’s I/O Conference, competitor OpenAI’s CEO Sam Altman testified before a Senate Judiciary subcommittee, “We think that regulatory intervention by governments will be critical to mitigate the risks of increasingly powerful [AI] models.”

OpenAI’s most famous product, the aforementioned ChatGPT, has taken the internet by storm but has also showcased AI’s weaknesses as much as its strengths. Now somewhat infamous for its so-called “hallucinations,” ChatGPT and similar products have repeatedly presented false or incorrect statements as fact. Altman has even described ChatGPT as “a horrible product” while appearing on The New York Times tech podcast "Hard Fork." He explained that they view their product as more of a version “0.7” than a fully polished “1.0.”

Ultimately, these products are pulling from a cluttered data set (content on the Internet) without being intelligent enough to discern high-quality sources from poor quality. That lack of critical thinking and a persistent inability to decipher what’s real or true is a tough challenge for all AI products.

Thus, concerns around AI are certainly well-founded, and we share many of them. Current AI products seem exceedingly skilled at repackaging poor quality content to make it seem higher quality, truer, or more accurate than it is; and to whatever extent users treat poor quality outputs as high quality, it creates risks for both businesses and their customers alike. This is not a formula for long-term success.

Yet this situation simply reaffirms our expectation that care and conscientiousness around the implementation of AI will become a – if not the – major area of competitive differentiation between AI offerings.

In other words, there's a real value to being the business whose AI products can successfully and consistently recognize that 95% of available inputs are not a good diet to feed your AI. Google’s historical emphasis on user experience and its emerging AI strategy, as articulated over the past month by Mr. Pichai, suggest it is well-placed to seize opportunities associated with its AI projects.

As always, we will continue to monitor developments in this space. If anything, this year has demonstrated that there are no true economic prophets. If someone had told us a year ago that the U.S. Federal Reserve was going to raise rates ten consecutive times to a 16-year high (as it reached in May), and yet the economy would (so far) maintain low unemployment and resilient consumer spending, we would have been skeptical. Add in volatility around monetary policy, the debt limit and/or default, and ongoing geopolitical instability (e.g., the ongoing Russian invasion of Ukraine), and the economic picture becomes even harder to predict.

In the midst of such unpredictability, we spend a lot of time thinking about how to best secure the GDS Investments portfolio. One lesson we take to heart is the need to identify equity positions which will not only survive but will continue thrive beyond the current environment. We seek companies with deep, wide, and durable economic moats that help to secure their market position. In uncertain times, holding well-defended companies is especially wise. As a result, GDS Investments will maintain its steady and proven course of value investing by always looking for high-quality, but undervalued, opportunities.

Glenn

484.888.9155