Three industries that will benefit from the AI boom

Proponents of artificial intelligence (AI) often tout productivity benefits that span virtually all industries and that will revolutionise how we define work while empowering employees through virtualisation and automation.

Generative AI does have significant potential, but only time will tell how much of that potential will be realised.

Like many others, we see the exciting side of developments in artificial intelligence and have positioned our portfolios to take advantage of companies that are early beneficiaries of the AI wave, and where we see tangible earning outcomes.

Consideration must also be given to the potential risks arising from AI, such as regulatory risk, consumer backlash, security, and privacy issues.

Opponents of AI conjure up scenarios of existential threat driven of an AI takeover or draw up parallels of the current AI boom to previous stock market bubbles and bursts.

These aspects about AI are yet to be fully understood. We are yet to fully explore and resolve the many issues and opportunities AI presents us.

As a result, we are cautious on how broadly AI apps can and will be monetised. We believe it will take longer to play out than anticipated, as the technology is developed, and its utility determined.

The early beneficiaries of AI

AI training

Large language models (LLMs) are algorithms that have the ability to summarise, predict and generate responses in human-like text formats, already making life easier for many of us.

But before they can be applied to solve a problem or complete a task and raise productivity tangibly, these models need to undergo what is known as 'training'.

This training refers to the initial phase of an AI model where data is fed into a machine learning model and, through a series of trial and error, emerges with a neural network that can consistently solve any challenges presented by the training algorithm.

Once a model is rigorously tested, it can then be deployed for various applications, and this phase is what we call 'inferencing'; when presented with problems, the AI tool will infer solutions with a relatively high degree of accuracy.

This is the reason why we continue to see rapid updates of LLMs, as more training data is processed to enhance their inferencing capability and the overall accuracy of AI tools.

Cloud service providers

Large cloud service providers such as Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN) and Alphabet's Google (NASDAQ: GOOG) have been an early beneficiary of the growth of AI.

For example, Microsoft recently reported 24% growth in cloud service revenues, and a meaningful 7% of this growth was attributable to identifiable AI related demand.

Microsoft is not only shaping up to be an early AI beneficiary, but one that offers significant growth potential, including assembling a powerful AI ecosystem outside of its cloud hosting capabilities, deploying AI Co-pilot across various products, investing in data services, leveraging its dominant Office 365 software suite and its highly strategic stake in the ChatGPT creator, OpenAI.

As we assess the implications of these developments, we anticipate that businesses such as Data#3 (ASX: DTL), one of the largest Microsoft licensing partners in Asia Pacific, will also enjoy these ecosystem benefits over the longer term, although we remain on the sidelines given the recent management changes and weakening domestic conditions for its enterprise IT sales.

Data centres

Another beneficiary we already see is data centre operators and developers that are exposed to these large cloud service providers, otherwise known as hyperscalers.

Hyperscalers themselves are pivoting away from a build, own and operate model when it comes to their infrastructure requirements and are instead leaning more on external data centre operators simply because the time to bring new capacity to market has increased significantly as a result of lengthening permitting processes and challenges with securing power supply.

In Australia, Infratil (ASX: IFT), which owns a stake in Canberra Data Centre (CDC) is one of the largest data centre developers and operators in Australasia.

We expect businesses like CDC will continue to benefit from the thematic of hyperscale demand growth over the medium term. NextDC (ASX:NXT) is a similar beneficiary.

Will we see the monetisation of AI in software?

Software companies are another beneficiary of AI, however, in this space there are varying views on whether they will be able to monetise AI apps and features over time.

Human resources and finance cloud platform, Workday (NASDAQ:WDAY), is one example.

It believes that all customers should be allowed equal access to AI functionality on its platform and is offering all users at least 50 different AI enhancements without charging incrementally for these.

The company's newly appointed CEO believes that some AI functionality will ultimately get commoditised over time.

In his prior role as a general partner at venture capital firm Sequoia Capital, he observed that many AI startups were building business models based on open-sourced LLMs and while there is an element of being first to market, this competitive advantage gets eroded quickly given the open-sourced nature of the underlying models. He anticipates that over time, many of these AI solutions will be in housed or replicated by the very customers of these AI startups today.

This view has been echoed by other in the tech industry including the Australian graphic design platform, Canva.

AI adoption and the investment case

Clearly there is still a lot to play out in widespread AI adoption. For instance, Microsoft stated that 65% of the Fortune 500 are already using their Co-pilot in some shape or form, but few have rolled this widely through their organisations.

Other bottlenecks to wider enterprise AI adoption include perennial concerns around data security and privacy as well as the lack of AI-readiness across many organisations, with both software and hardware needing to be upgraded in order to take advantage of AI capabilities that are on offer.

We are excited about the developments in AI and have positioned our portfolios to take advantage of companies that are early beneficiaries of the AI training wave, including the cloud service providers and data centres, and where we believe there are tangible earning outcomes.

But when it comes to AI deployment more widely, we are cautious and believe this will take longer to play out. We continue to look for more evidence from companies around the monetisation of AI solutions before factoring these into our investment cases.

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