Microsoft's investment into ChatGPT's creator may be the smartest $1 billion ever spent

• Microsoft's $1 billion investment into OpenAI may be one of the shrewdest bets in tech history.
• OpenAI released AI bot ChatGPT and is in discussions to raise capital at a $30 billion valuation.
• If ChatGPT lives up to its potential, Microsoft may have future proofed its cloud and browser business forever.

It has looked, over the past few months, like Big Tech's bull run is coming to end. As interest rates soar, even cash-rich tech companies are pulling back on risky, expensive moonshots or money-losing projects.

But one speculative bet is increasingly looking like excellent value for money.

In 2019, Microsoft invested $1 billion into the buzzy artificial intelligence research outfit OpenAI, cofounded by Y Combinator alum Sam Altman, Elon Musk, and a group of others just over seven years ago. Financial details of the deal weren't disclosed at the time, but MIT Tech Review reported in 2020 that the $1 billion was split between cash and credits for Azure, Microsoft's cloud business. Insider has approached both firms for comment.

In November, OpenAI released a user-friendly bot, ChatGPT, based on its GPT-3.5 language model which was trained on Azure. Engineers, academics, entrepreneurs, non-techies, and investors were near-universal in their hype and praise as ChatGPT proved scarily intelligent (up to a point). Even if flawed, ChatGPT is sufficiently smart that Google sees the chatbot as a "code red" for its search business.

Now OpenAI is reportedly in discussions to raise more capital at a valuation close to $30 billion — up from a current $20 billion valuation — and is in discussions with Peter Thiel-run VC firm Founders Fund, according to reports. The valuation would be cemented through a tender offer involving the sale of existing shares to investors.

Apart from the ROI, Microsoft's deal only looks smarter as more details emerge.

The Information reported that the company could integrate ChatGPT into Bing, its flailing Google competitor. As Insider's Emilia David writes, that's the first real threat to Google's search hegemony in two decades.

ChatGPT could fuel growth for Bing and Azure

Gil Luria, director of research at DA Davidson, an investment bank, wrote in a note on Wednesday that "Microsoft deserves a premium valuation relative to the market" with its "investment in OpenAI as a source of upside." 

"We believe Microsoft's investment in OpenAI will translate to significant underappreciated upside," Luria wrote. He added that  "the unprecedented activity" in ChatGPT is "translating to incremental volumes for Azure."

Luria said there are estimates of between $250 million and $1 billion annual run rate of expenses at OpenAI, "much of which is likely being spent on Azure." 

Even with the Azure credit bung, OpenAI will need to start spending hard cash on Microsoft's infrastructure eventually, provided the tech giant negotiated exclusivity — ChatGPT has already crossed 1 million users, according to Altman.

OpenAI itself expects $1 billion in revenue by 2024, according to Reuters. DA Davidson expects those levels to increase significantly with the introduction of OpenAI's GPT 4, its next-generation AI model, later this year. 

Bing too has room to grow.

Luria estimates with $120 billion of annual run rate revenue, Google Search represents most of Google's $1.1 trillion of value, while Bing, at around $11 billion of run rate revenue, represents "at most" 5% of Microsoft's revenue and value.

"Longer-term, we believe incorporating ChatGPT capabilities into Bing may provide Microsoft with a once-a-decade opportunity to unseat Google's Search dominance," he wrote.

Investors may be souring on speculative tech but AI looks resilient

There is speculation that Microsoft may look to buy OpenAI. But an investment rather than a buyout gives it flexibility and room to experiment.

Google, by contrast, bought London-based DeepMind in 2014 and has mostly seen its acquisition lose money, since it's expensive to own and operate what is effectively a private research faculty. DeepMind spends about half a billion dollars on staffing costs alone annually.

And while investors may be generally souring on tech, the field of artificial intelligence remains resilient.

Figures from data firm Pitchbook suggest that VC investment in AI hit $1.37 billion in 2022 across 78 deals, representing almost the total invested over the past five years. Other sectors saw declines, by contrast. 

That suggests investors will still look to pile into the hottest AI companies, cementing the value of Microsoft's deal.

"Near-term challenges facing financial markets could result in improved deal terms for investors, which could ultimately lead to heightened returns in the future," Nalin Patel, lead analyst of EMEA private capital at Pitchbook told Insider. "Therefore, investors will be keen to deploy capital into companies operating in nascent areas with strong long-term growth potential, such as OpenAI."

In a research note, Pitchbook senior analyst Brendan Burke said that in 2023, AI startups "will stand out" by applying something known as imitation learning to AI foundation models — a means of training general AI models to carry out specific tasks.

Specifically, the excitement in imitation learning, he noted, comes from the potential to "produce commercial business models", particularly if "they are embedded within foundation models such as OpenAI's upcoming GPT-4."

OpenAI has made imitation learning a key area of interest, having published a paper in June 2022 about a neural network trained to play Minecraft after watching 70,000 hours of videos online.

OpenAI's eventual growth and profitability is not a slam dunk. There have been several "AI winters" which saw interest in research and funding drop off. And slow progress in some areas — like self-driving cars — has fueled skepticism when it comes to AI working in the wild.

And Burke noted that AI features such as imitation learning remain "unproven in a commercial context and may suffer from a lack of quality data on user task completion." Ethicists also fret about how black-box AI could be abused.

Still, 2022 felt like a genie-out-of-the-bottle moment thanks to ChatGPT and the popularity of OpenAI's generative image model DALL-E. 

Microsoft may find it's futureproofed itself with just $1 billion.