3 Things Alphabet Investors Need to Know About Google’s Cloud Business

There’s no denying that parent Google Alphabet (GOOG 1.17%) (GOOGL 1.11%) is facing an alarming legal challenge right now. The Department of Justice (DOJ) has successfully argued that it is a monopoly… in more ways than one.

The company plans to appeal the ruling, of course, but in the meantime it’s bracing itself for having to reject the DOJ’s recommendations for remedies. A divestment of its Android operating system and/or its Chrome web browser are both possibilities, and Alphabet’s payments to third parties to make Google its suggested search engine could also be coming to an end. We will know more in September after the decision-making phase of the process begins.

Here’s the good news: Google is a proven powerhouse and has been in similar situations before. So the headlines might make the issue seem more of a threat than it really is. Even if the company is forced to abandon Chrome or Android, or have to share more data with competitors, it will be fine.

Indeed, Alphabet is likely to be even healthier in the near future for reasons unrelated to its web search business. Google’s cloud computing arm is an underrated growth engine for three reasons investors may overlook.

How Google Cloud Makes Alphabet Stock a Buy

1. Growing market share

Alphabet competes with people like Amazon (NASDAQ: MSFT) and Microsoft (NASDAQ: MSFT) on the cloud computing front. Enterprises that prefer not to make major upfront investments in their own cloud infrastructure can simply tap Google (or a competitor) to handle this work remotely.

Google isn’t a huge cloud computing player, mind you. It is much smaller than Microsoft’s operation in this market, which is much smaller than Amazon Web Services (AWS). However, figures from Synergy Research Group indicate that Google Cloud’s share of the global cloud computing market is growing. Faster than the share of any of its rivals.

Data source: Synergy Research Group. Chart by author.

Of course, sometimes it can be easier to gain momentum when starting from a smaller base, while bigger players have a harder time moving the needle as much. In the cloud computing industry, however, greater scale is normally a competitive advantage, so it appears that Google Cloud is simply doing something better than its competitors.

This growing degree of market share should persist for the foreseeable future if the core computer processing architecture has anything to do with it.

2. New chips

To date, most cloud computing data centers (including those focused on artificial intelligence tasks) have been based on processors and chips that performed well enough, but were re-engineering of technology designed for other purposes. For example, Nvidiahis (NASDAQ: NVDA) The earliest AI processors were mostly just repurposed graphics cards, incidentally capable of handling the huge amount of data required in AI applications.

As the next chapter of the AI ​​revolution unfolds, we need better technology.

That’s where Google’s new Axion chips come into play. Based on Arm holds‘ (NASDAQ: ARM) architecture, internally designed Google Axion processors deliver 30% better performance than similar general-purpose microchips and 50% better performance than mainstream processors manufactured by Intel (NASDAQ: INTC) or Advanced microdevices. Perhaps most importantly, Google’s Axion-based cloud platforms will legitimately compete with Nvidia’s solutions, which have dominated the AI ​​market largely because there hasn’t been a viable alternative.

3. The margin is moved

Last but not least, Google Cloud may finally be profitable, but it’s still far from contributing to the company’s bottom line as much as it eventually will.

The chart below tells the story. Google’s cloud business posted an operating profit for the first time in the first quarter of last year and has steadily increased that net income in line with revenue growth. Of the $10.3 billion in cloud computing revenue last quarter, nearly $1.2 billion — about 11 percent — was converted to operating income. Not bad.

Data source: Alphabet. Chart by author. Revenue and operating income figures are in the billions.

But that’s just a fraction of the kind of margins Google Cloud’s top rivals are seeing with their cloud businesses. In the first half of this year, AWS boasted an operating profit margin of 36%. Microsoft’s cloud operating income was in the order of 45%. If Google Cloud was already so profitable, Q2 operating profits would have been $4 billion, rather than just $1.2 billion.

For perspective, Alphabet’s total operating income last quarter was $27.4 billion.

Connect the dots. Google Cloud has the potential to make a serious bullish dent in Alphabet’s bottom line, especially given the continued growth of the cloud computing industry. Market research company Mordor Intelligence believes that the global cloud market will expand at an annual rate of more than 16% until 2029.

Alphabet stock still has plenty of upside

None of this is to suggest that current and potential shareholders should ignore Alphabet’s current legal troubles. Even if all the company’s appeals are successful, regulators are still clearly targeting big tech. The organization will be forced to change at least some aspects of its business sooner or later, and those changes will likely weaken the leverage that Alphabet currently enjoys.

But I’m confident that even if potential DOJ remedies undermine its business, the company will find a way to win.

Meanwhile, the market is undoubtedly underestimating how much profit Google Cloud could ultimately add to the bottom line. It may offset any profit setbacks suffered in connection with the DOJ’s moves.

In other words, there are still more reasons to own this stock at the current price than not.