Google: CIO Appointment And Cloud Profitability In The Limelight
Contributor since 2012 / 11024 Followers
Summary:
- Alphabet’s current CFO will be assuming the new role of Chief Investment Officer on September 1, which I view as a significant development.
- Google Cloud has significant room for profitability improvement, given that its current operating margin is way lower than that of its key peers.
- I stick to my existing Buy rating for Alphabet, following a review of the Google Cloud segment’s recent quarterly performance and assessing the implications of the new CIO role.
Alexander Koerner
Elevator Pitch
Alphabet Inc. (NASDAQ:GOOGL, NASDAQ:GOOG), commonly referred to as Google, continues to deserve a Buy rating in my opinion. With my prior April 7, 2023, update, I evaluated Google’s prospects for the long run, or more specifically, over the coming 10 years.
My attention turns to Alphabet’s new Chief Investment Officer appointment, and Google Cloud’s role in improving the company’s future profitability in this write-up.
I think that Alphabet’s new Chief Investment Officer will put the company in a better position to extract value from its Other Bets business segment and deal with regulatory challenges. Also, Google Cloud’s recent financial and operating metrics are pretty healthy, and this business segment is expected to deliver robust top line expansion and higher profit margins going forward. I decide to retain a Buy rating for Alphabet after considering the above-mentioned factors.
New Chief Investment Officer Role For Alphabet
Late last month, Seeking Alpha News reported that Alphabet’s current CFO Ruth Porat will be taking on “the newly created role of chief investment officer” on September 1 this year. Ruth will be serving as both Chief Investment Officer (or CIO) and CFO of the company till Alphabet finds a new CFO to succeed her.
I take the view that having a new Chief Investment Officer is a favorable development for Google.
In its July 25, 2023, filing, disclosing this new CIO appointment, the company disclosed that Ruth Porat “will be responsible for Alphabet’s investments in its Other Bets portfolio” and “focus on engagement with policymakers and regulators. Alphabet’s CEO Sundar Pichai was quoted in this corporate filing as emphasizing that Ruth “will strengthen our collaboration with policymakers and shape our corporate investments.”
Based on my interpretation of Alphabet’s statements highlighted above, my opinion is that Ruth Porat, in her new role as CIO, will be focused on narrowing losses and unlocking the value of the company’s Other Bets business segment, while optimizing the company’s regulatory risk management approach.
Alphabet describes its Other Bets segment as a portfolio of “early-stage businesses” which are “using technology to try to solve big problems” in its fiscal 2022 10-K filing. In the first half of 2023, Google’s Other Bets segment suffered from an operating loss of -$2,038 million.
There are signs that Google has become more eager to reduce operating losses incurred and realize the value of its investments for the Other Bets segment. A recent August 17, 2023, Seeking Alpha News article citing a report from Wall Street Journal mentioned that Alphabet’s “health venture Verily Life Sciences is planning additional cost cuts.” At its FY 2022 earnings call in early February this year, Ruth Porat stressed that Alphabet has its eyes on “opportunities for monetization and commercialization” within the portfolio of businesses grouped under the Other Bets segment.
As such, it is realistic to expect Ruth to continue with value-unlocking efforts targeted at the Other Bets business segment, which will likely translate into lower costs and higher revenues.
Separately, Ruth Porat is expected to play a bigger role in helping Alphabet to operate effectively in the challenging regulatory environment as CIO. Considering that Google has a dominant position in Search and the company is increasing its investments in AI-related areas, it is inevitable that Alphabet will still be faced with meaningful regulatory risks going forward.
Prior to becoming CFO at Alphabet in 2015, Ruth was also formerly CFO at Morgan Stanley (MS), which operates in the highly regulated financial services industry, since 2010. In fact, Ruth Porat worked at MS in various roles for almost three decades. This implies that Ruth has the relevant experience to work more closely with the regulatory agencies to advance Alphabet’s interests.
In a nutshell, the creation of the new CIO role and getting the current CFO to assume that role are much more significant moves than what they appear to be on paper.
Google Cloud Holds The Key To Alphabet’s Profitability Improvement
The market sees Alphabet’s profitability improving in the next couple of years. In specific terms, Wall Street predicts that Google’s EBIT margin might potentially expand from 27.7% in FY 2023 to 29.9% (source: S&P Capital IQ) for FY 2027, while the company’s normalized net margin is projected to increase from 23.5% to 26.0% during the same time frame.
Alphabet’s Google Cloud segment accounted for 10.7% of its 1H 2023 top line, but the company only earned 1.5% of its first half operating income from Google Cloud as indicated in its Q2 2023 10-Q filing. Google Cloud’s second quarter operating margin was a modest 4.9%, but this business segment only began generating positive quarterly operating profit in Q1 2023. Therefore, it is natural to expect that Alphabet’s overall profitability improvement is very much dependent on the profit margin expansion for Google Cloud in the future.
Scaling up the Google Cloud business and realizing the positive effects of operating leverage are what is needed for this business segment to achieve higher margins in the quarters and years ahead. The Google Cloud business saw a +28.0% YoY increase in segment revenue to $8,031 million in Q2 2023, and there are metrics which imply that Google Cloud’s positive revenue growth momentum is very likely to be sustained. Alphabet revealed at its Q2 2023 results briefing that over “70% of gen (generative) AI unicorns are Google Cloud customers”, and highlighted that Google Cloud’s “Vertex, Search and Conversational AI platforms” saw the “number of customers growing more than 15x from April to June.”
Google Cloud’s key peers might offer an indication of the kind of profit margins that this business could potentially earn in the future when it scales up. Microsoft’s (MSFT) Intelligent Cloud boasted an operating margin of 43.1% for the most recent fiscal year, while the recent quarterly operating margin for Amazon’s (AMZN) AWS (Amazon Web Services) was 24.2%.
Closing Thoughts
I leave my Buy rating for Google unchanged, as I view the newly created CIO role and Google Cloud’s good Q2 2023 performance as positive signs for the company.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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