While it is not a major profit center right now, over time it could become a major profit center and help further offset the Department of Justice’s moves.
There’s no denying that Google’s parent company, Alphabet (GOOG +1.17%) (GOOGL +1.11%), is currently facing a surprising legal challenge, with the Department of Justice (DOJ) successfully alleging that the company is a monopoly in many ways.
The company intends to appeal the ruling, of course, but in the meantime it’s preparing to fend off Department of Justice recommendations for remedies, including a possible sale of both the Android operating system and the Chrome web browser, and an end to payments Alphabet makes to third parties to make Google the preferred search engine. We’ll know more in September, when the decision-making phase of the trial begins.
The good news is that Google is a big, established company that has been in similar situations before, which is why the headlines may be making this seem like a bigger threat than it actually is — even if the company is forced to give up Chrome or Android or is asked to share more data with competitors, it won’t be a problem.
In fact, Alphabet is likely to be even healthier in the near future for reasons that have nothing to do with its web-search business: Google’s cloud-computing division is an undervalued growth engine for three reasons investors might overlook.
Why Google Cloud is making you buy Alphabet stock
1. Increased market share
Alphabet competes with companies like Amazon (NASDAQ: MSFT) and Microsoft (NASDAQ: MSFT) in cloud computing, and companies that don’t want to make large up-front investments in their own cloud infrastructure can simply hire Google (or a competitor) to handle this work remotely.
To be clear, Google is not a cloud computing giant: It operates a much smaller portion of the market than Microsoft, which in turn operates a much smaller portion than Amazon Web Services (AWS). And yet, according to figures from Synergy Research Group, Google Cloud’s share of the global cloud computing market is actually growing faster than either of its rivals.
Data source: Synergy Research Group. Chart by authors.
Sure, it can be easier to gain share when you start with a small base, but it’s harder for larger players to make big changes. But in the cloud computing technology industry, scale is usually a competitive advantage, so it looks like Google Cloud is simply doing something better than its competitors.
If the underlying computer processing architecture has anything to do with this, then this market share growth should continue into the foreseeable future.
2. New chip
Until now, most cloud computing data centers, including those focused on artificial intelligence tasks, have relied on processors and chips that worked well but were repurposed technology designed for other purposes. For example, Nvidia’s (NASDAQ: NVDA) early AI processors were mostly just repurposed graphics cards that just happened to be able to process the massive amounts of data required for artificial intelligence applications.
As the next chapter of the AI revolution unfolds, we will need better technology.
That’s where Google’s new Axion chips come in. Based on Arm Holdings’ (NASDAQ: ARM) architecture, Google’s homegrown Axion processors offer 30% better performance than similar commodity microchips and 50% better performance than basic computer processors made by Intel (NASDAQ: INTC) and Advanced Micro Devices. Perhaps most importantly, Google’s Axion-based cloud platform will legitimately compete with Nvidia’s solutions, which have dominated the AI market because there was no viable alternative.
3. Margin Movement
Last but not least, while Google Cloud may eventually turn a profit, it’s still a long way from ultimately contributing to the company’s overall bottom line.
The chart below tells the story: Google’s cloud business first posted operating profit in the first quarter of last year, and has steadily grown this net profit in line with revenue growth. Of the $10.3 billion in cloud computing revenue last quarter, about $1.2 billion (about 11%) was converted to operating profit. Not bad.
Data source: Alphabet. Graph by author. Revenues and operating profit in billion.
But that’s just a fraction of the margins Google Cloud’s biggest rivals are making on their cloud businesses. In the first half of this year, AWS boasted a 36% operating margin. Microsoft’s cloud operating margin was around 45%. If Google Cloud was already making that much, its second-quarter operating profit would likely have been around $4 billion, instead of $1.2 billion.
For comparison, Alphabet’s total operating profit last quarter was $27.4 billion.
Let’s connect the dots. Given the continued growth of the cloud computing industry, Google Cloud could be a significant contributor to Alphabet’s bottom line. Market research firm Mordor Intelligence predicts that the global cloud market will grow at an annual rate of more than 16% through 2029.
Alphabet shares still have plenty of room to grow
This is not to suggest that current or future shareholders should ignore Alphabet’s current legal problems. Even if the company is successful in all of its appeals, it is clear that regulators are still targeting big tech companies. Sooner or later, the company will be forced to change at least some parts of its business, and those changes will likely weaken the influence Alphabet currently enjoys.
But even if a future DOJ bailout deal hurts the company’s business, I’m confident the company will find a way to win.
Meanwhile, the market is likely underestimating how much profit Google Cloud will ultimately bring to the bottom line, which could well offset the profit hit associated with the Justice Department’s move.
In other words, there are still more reasons to hold this stock at its current price than not to hold it.
Suzanne Frey, an executive at Alphabet, serves on The Motley Fool’s board of directors. James Brumley owns shares of Alphabet. The Motley Fool owns shares of and recommends Advanced Micro Devices, Alphabet, Microsoft, and Nvidia. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls on Intel, long January 2026 $395 calls on Microsoft, short August 2024 $35 calls on Intel, and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
