Google: Why I See Steep Further Downside On Cloud Weakness
Contributor since 2014 / 3259 Followers
Summary:
- Google’s disappointing Q3 earnings and underperformance in the cloud business indicate further stock decline.
- Microsoft’s Azure cloud segment is outperforming Google, and analysts predict it will continue to gain market share.
- Microsoft’s dominance in business applications and AI technology gives it an advantage over Google in securing major deals and partnerships.
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Google parent Alphabet (NASDAQ:GOOG) just released third-quarter earnings which disappointed analysts with the stock down 11% for the week. I believe the stock will fall further and will explain why.
A sluggish cloud is a sign of things to come
Alphabet’s Google Cloud business failed to meet investor expectations in its third-quarter earnings and the stock suffered as a result. Despite beating expectations with an 11% year-on-year profit at Google, the cloud reported revenue of $8.411 billion, less than analyst’s estimates of $8.64 billion.
The problem for Google is that Microsoft’s Azure cloud segment was able to post its first growth since 2022. The rival’s management also guided for cloud growth at the higher end of expectations for the full year 2024.
At the start of 2023, Amazon had a market share of 33% in the cloud, with Azure at 22% and Google at 11%. I believe that Google will have an uphill battle trying to close the gap on Microsoft.
Amazon also posted stronger cloud revenue with a 12% gain over the same period last year. But more important was management’s tone, with positive comments on the company’s custom chips and coding tool. They also noted large corporations had adopted AI workloads on AWS, including Adidas, Booking.com, and GoDaddy.
Analysts are now seeing the third quarter earnings as the writing on the wall for Google.
Microsoft has invested heavily in artificial intelligence but additional revenue has not affected Intelligent Cloud gross or operating margins, which both grew in Q3.
“While Alphabet management notes Google Cloud Platform continues to grow faster than reported results, we believe limited disclosures are creating concerns that Google lost share to Microsoft Azure,” KeyBanc analyst Justin Patterson said.
Amazon didn’t choose Google for its $1BN productivity license
Another big development recently was the announcement that Amazon was set to ink a $1 billion deal with Microsoft to use its 365 productivity package.
This is a deal over five years which is made possible by Amazon’s scale, as it will involve 1 million licenses. But, there is a growing possibility that many more will follow and Microsoft is the daddy of business applications. Amazon didn’t use Google and Microsoft’s dominance in PC and enterprise hardware will put them in pole position for further deals.
Microsoft’s vice president for investor relations, Brett Iverson, outlined the future for the company when he said that the third quarter sales growth this week was driven by customers rekindling their use of Microsoft’s cloud ahead of the AI movement.
“What AI is doing … is opening up either new conversations or extending existing conversations or getting us back in touch with customers that we maybe weren’t doing as much with”, Iverson said. I believe this is the strength of Microsoft’s offerings in AI, with dormant customers looking to see how AI works’ for their own businesses.
Microsoft has 365 and Google has its own suite of productivity tools, with both releasing $30 per month premium subscriptions in the last months. But the first evidence shows that CEOs and enterprises that will tap into artificial intelligence more than the private users and Google will get left behind.
Google stated in 2019 that 5 million businesses were paying for G Suite, while Microsoft’s Office 365 suite had 200 million monthly active users. That highlights what is to come for both companies and their $30 per month effect on revenue.
Microsoft is the preferred partner for businesses, colleges, government offices, and more. Any AI boom will boost the company over Google.
A deeper look at Alphabet’s third quarter
One of the problems with Google’s latest earnings call is a lack of clarity on the potential revenue coming in the pipeline from AI. The company is still looking at a tough macro environment as global conflicts increase and they will need money to invest in AI and fend off the competition.
Comments from the company’s CFO Ruth Porat, highlighted evasive language, without clarity on client activity, like that seen at Amazon.
“We see strong engagement with our products and services, and we’re putting money confidently into this area, expecting good things,” Porat said. “We’re happy with how we’re doing operationally, and we’re working hard to manage our costs while going after our top growth plans, especially in AI.”
CEO Sundar Pichai also failed to provide clarity on the weak cloud performance, simply saying that things were “picking up.”
In the end, Alphabet can talk about being a big AI player but its business model is reliant on the Services segment. That is dominated by advertising, app sales, and YouTube. Google is not going to have near-term upside on monetizable AI in my opinion.
After the AI hype started around January, Microsoft went from $36.2 billion in revenue for the March quarter to $40.21 billion this time. Alphabet posted similar results with a $39.2 billion revenue in March to $43.46 billion this week.
I believe that both companies were on a similar growth trajectory based on the macroeconomic environment, but Google will start to lose its luster as the AI dream proves to be a bust. Using AI to predict the weather on Google Maps is a nice gimmick but is not monetizable beyond current revenue streams.
Google still dominates in search
If there is a downside to the investment thesis then it is in search. Microsoft is unlikely to challenge Google’s dominance in search, trailing in market share by around 80% to 10%, but the former did see a pickup after implementing a ChatGPT in January.
However, the initial rush to the chatbot was built on hype and curiosity and as I mentioned previously, I believe that enterprises are going to be the early drivers of AI technology. If more and more companies adopt Microsoft’s cloud, that will require more integration of Bing. Amazon is also seeing tangible gains from clients and predicted $10 billion in revenue from cloud over the coming years.
My February 2023 short call on GOOG was too early to fade the AI strength. The initial increase in Bing users due to ChatGPT was still too early to create a real change of large-scale adoption. Google has since been afforded a higher valuation and I believe it will return to the price of my earlier call as we pass further quarterly earnings releases.
To summarize, I believe that Alphabet will continue to be a bellwether tech stock, but heavily reliant on the advertising environment. Its rival Microsoft will be the growth stock, capitalizing on AI growth for its current products, and GOOG shares could lose much of their 2023 AI premium of 37% if management continues to use AI as a buzzword without any execution.
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