Since OpenAI debuted ChatGPT a year ago, Microsoft’s stock has added more than $900 billion in market capitalization, and those two events are widely viewed by market participants as being related.
Altman has now been reinstalled as CEO of OpenAI, but the drama during that uncertain weekend reinforced to investors just how important OpenAI is to Microsoft’s future. Those investors know little about the relationship between Microsoft and OpenAI, though, because Microsoft says little about it.
More than four years after the companies officially established what Microsoft describes as a “partnership,” Microsoft has disclosed very little in its securities filings about its partnership with OpenAI, and has not detailed the terms of its reported investment in the startup in its filings with the Securities and Exchange Commission, or in any other official corporate communications.
Microsoft’s description of its relationship with OpenAI in its most recent annual report filed with the SEC comprised a relatively perfunctory 54 words; for comparison, a section disclosing Microsoft’s “commitment to sustainability” two pages later in the same document runs nearly 300 words. On OpenAI, Microsoft’s securities filings say only that OpenAI is a “strategic partner” providing large-language models to Microsoft, Microsoft’s Azure is powering OpenAI’s business, and that the two are working together on supercomputers, along with two rather standard risk factors.
“Microsoft does not disclose specifics of the financial and deal terms. All that is publicly shared is that it is a multiyear, multibillion-dollar investment,” a Microsoft spokesperson told MarketWatch when asked about disclosure of the OpenAI deal. Microsoft also pointed to a single blog post that describes “the third phase of our long-term partnership” and has never been officially filed with the SEC.
In a follow-up conversation, Microsoft confirmed that it does not view its partnership with OpenAI, nor its investment in OpenAI, to be material to the business.
While Microsoft hasn’t directly disclosed the extent of its ownership in OpenAI, some terms of the deal between Microsoft and OpenAI have been widely disseminated, but only based on anonymous sources. The Wall Street Journal and the New York Times, among other news organizations, have reported that Microsoft agreed to pour $13 billion into OpenAI and receive a stake in the company near to but not reaching 50%. There have also been news reports that at least part of Microsoft’s investment is being made in the form of credits for Azure cloud-computing usage. OpenAI is also reportedly approaching a $90-billion valuation, according to Bloomberg News and The Wall Street Journal, which would mean that investments in the company in 2019 and 2021 would be worth more now.
What is material to Microsoft?
Federal securities law requires that publicly traded companies disclose material information to investors, but what a company deems as material can be open to interpretation, experts on securities law say. While the size of Microsoft’s reported investment in OpenAI is small relative to the size of one of the most valuable businesses on the planet, the importance of the partnership is a different and more nuanced consideration.
“Information is material if there’s a substantial likelihood that the disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available,” explained Andrew Baker, an assistant professor of law at University of California, Berkeley. “And so the question is, would a reasonable investor have viewed this piece of information as important when making an investment decision?”
That legal standard is not quantitative — it doesn’t automatically kick in if a deal or investment reaches, say, 5% of annual profit or revenue, though executives do tend to use those rules of thumb for disclosure, say experts in securities law. The dollar amount relative to the size of the company can come into play, though, an entity such as Microsoft, which generated more than $211 billion of revenue in its most recent fiscal year, can therefore attempt to avoid disclosing investments like the $13 billion Microsoft is reportedly investing into OpenAI.
Olga Usvyatsky, an accounting expert and former VP of Audit Analytics who recently wrote an analysis on Microsoft’s OpenAI disclosure, believes that Microsoft could reasonably argue that the investment specifically is not material on quantitative grounds.
“$10 billion would not make a dent quantitatively on their financial statements,” especially if part of the payment was made in cloud credits, she said. “Even if everything was paid in cash, I suspect the additional $10 billion in cash is also immaterial to Microsoft.”
“‘You saw the stock price of Microsoft move around this. So it’s kind of hard to argue ex-post that this stuff wasn’t material when all this news was happening and everyone was pointing out that stock price was changing rapidly for Microsoft, which suggests that the market views it as material — the market thinks that this is going to have an important impact on Microsoft’s business.’”
But there are issues beyond the investment amount, especially when it comes to the arrangement that exists between OpenAI and Microsoft, said Stephen Diamond, a Santa Clara University law professor who specializes in securities law.
“On the objective dollar amount [of the investment], you’re not going to get the materiality that would require them to disclose, but you could make the case that AI itself is central to your business model moving forward so you owe investors more clarity about your relationship with OpenAI,” Diamond said.
Microsoft executives have recently detailed growth in their core Azure cloud-computing business as a result of generative-AI workloads, and described the OpenAI relationship as central to those efforts, as well as to the entire future of the company’s many segments.
“There’s an investment part to it, and there’s a commercial partnership. But fundamentally, it’s going to be something that’s going to drive, I think, innovation and competitive differentiation in every one of the Microsoft solutions by leading in AI,” Nadella said in a January conference call about the deal with OpenAI.
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After Microsoft reported growth in its key Azure cloud-computing unit based on AI workloads in a recent quarter, Nadella praised those gains, describing them as material.
“We have significant scale. And so, yes, we celebrate. That’s why we’re even giving you the visibility, one point of it showing up this quarter, a couple of points showing up next quarter. And those are material numbers,” Nadella said in Microsoft’s June earnings call.
Microsoft declined to discuss the apparent disconnect between that statement and its contention that the deal with OpenAI is not material, while pointing to statements that detail a wider breadth of AI offerings within Azure, including models from Meta Platforms Inc.
and Hugging Face.
‘Value beyond dollars and cents’
Wall Street analysts and Microsoft executives have made the case that AI generally — and OpenAI in particular — are central to Microsoft’s investment thesis moving forward. Wedbush analyst Daniel Ives has written that “the core AI technology by OpenAI is, at the essence, the core hearts and lungs of Redmond’s Copilot and enterprise strategy,” while Oppenheimer analysts insist that Microsoft and OpenAI are “physically, technologically and financially intertwined.”
“The OpenAI partnership has value beyond dollars and cents — it is important to the perception that Microsoft’s position is superior to Google
and others in the AI race,” Melius Research analysts wrote in November.
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Microsoft executives have spoken at length about how important the OpenAI partnership is to the future of the company. Microsoft is using OpenAI technology to develop “Copilots” for its software offerings — AI-powered helpers within products that act similarly to ChatGPT — and Nadella in November at Microsoft’s Ignite conference said that “it’s clearly the age of Copilot.”
In a recent earnings call, Microsoft Chief Financial Officer Amy Hood explained how tied the two companies are, saying: “When we grow, it helps [OpenAI]. And when they grow, it helps us.”
Baker, the Cal law professor who focuses on securities regulation and corporate governance, said that Nadella’s actions and the stock’s movement in the wake of the OpenAI executive tumult are proof of materiality in and of themselves.
Baker said the fact that Nadella, the CEO of the world’s second most valuable company, rushed to make a dramatic offer to hire Altman and other OpenAI employees, together with Nadella conducting television interviews on the issue, suggests OpenAI is very important to Microsoft. “You saw the stock price of Microsoft move around this. So it’s kind of hard to argue ex-post that this stuff wasn’t material when all this news was happening and everyone was pointing out that stock price was changing rapidly for Microsoft, which suggests that the market views it as material — the market thinks that this is going to have an important impact on Microsoft’s business.”
Microsoft has long been quiet in its securities filings about other parts of its business. For example, the company has never disclosed the independent financial performance of Azure, which has been the main driver of its stock for years, even as its major competitors in the cloud-computing space — Amazon.com Inc.
and Alphabet Inc. — break out the performance of their rival services.
Alphabet, Google’s parent company, began breaking out the financial performance of Google Cloud after the SEC spent years fighting for more disclosure from the search giant on its different products, largely focused on YouTube. Microsoft has not received similar public pushback from securities regulators over its disclosure practices. Baker said publicly traded companies sometimes try to limit their disclosure to avoid securities litigation from shareholders when their stock performs poorly.
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According to Santa Clara professor Diamond, Microsoft may also be attempting to avoid divulging important information that could help competitors. If the relationship with OpenAI is considered material, then Microsoft would have to file details of its deal with the startup, called a “material agreement.” As Amazon, Google and other Big Tech companies sign their own deals with AI startups to compete with Microsoft, knowing what terms exist in that deal would be helpful to them.
“It’s a very competitive setting [and AI] has become newly recognized as critical and taking on certain momentum, and they’re managing their competitive position,” he said.
Francine McKenna, a former lecturer at Penn’s Wharton School of business who writes about accounting and auditing issues and previously worked for MarketWatch, pointed out that Microsoft could request for redactions or confidential treatment for a material agreement. She believes that it will take heat from the SEC to force Microsoft’s hand on the issue.
“Everybody and their brother would say investors are interested in this. The rules seem to point to them having to disclose this,” she said in an interview. “We’ve seen with other cases, like Google, where they will resist up until the last minute. Why? Sometimes it doesn’t seem to make any sense, and we have to wait until the SEC forces it.”
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