Source: Leverage Shares

Overall, it can be seen that “Services” has witnessed progressive growth, thus making the burden of the other income-negative segments progressively easier to bear. It bears noting that the company’s long-in-the-making “Cloud” business is beginning to bear fruit in 2023 by finally turning weakly income-positive. Overall, its “Other Bets” (i.e. the likes of Waymo, Wing, et al) continue to consume cash. The 1st-order matrix reaffirms the dominant position occupied by “Services” while the wild swings in the 2nd-order matrix without really changing the segment share largely mirrors the “wax-and-wane” dynamic seen in the geographical estimates.

Outside of the numbers, however, the company’s growing “corporate costs”, which includes the costs borne by layoffs, litigation, et cetera continue to grow on an absolute basis. In 2023, the cost associated with downsizing office space in the wake of the company’s substantial layoff is a dominant feature. At the same time, it also highlights a somewhat tacit admission that growth is no longer a matter of personnel. What the company needs, instead, are new markets.

Alphabet remains dependent on ad spends. Advertisers are driven to spend to fulfill an outreach towards customers. However, in the region of greatest revenue contribution, i.e. the United States, overall consumer purchases are in decline. One interesting “proxy” for consumer behaviour could be represented by recent events at United Parcel Service (better known simply as “UPS”): after months of negotiations with the unions, the company announced the cutting of 12,000 jobs², followed by a warning that parcel volume is likely to decline in the first half of the year (like most of 2023) followed by an expectation of some recovery in the second half of the year. Given its dependence on ad spends in America, this is a key factor in the deflation of forward-looking sentiment.

To maintain the company’s “Magnificent” status, an “explosive growth” rationale is needed. The AI theme has been a key driver for many a stock over the past year. On the front, the company finds itself on the backfoot (at least presently).

A Missing Edge?

For Alphabet, any imputation of AI driving revenue will be integrated into the performance of its segments. AI’s contribution to “Services” would likely be most visible as some estimation of greater search and ad matching efficiency as well as increased buy-ins into the cloud business by enterprises. In the former, this isn’t apparent yet.

In the latter, however, Alphabet is at least one or two beats behind the likes of Microsoft, which stated in its earnings call³ that Azure AI, by virtue of offering top performance for AI training and inference as well as the most diverse selection of AI accelerators – including the latest from AMD and Nvidia – has again made market share advancements in this past quarter. Microsoft CEO Satya Nadella stated that Microsoft is now infusing AI across every layer of its products and services, as a result of which it is winning new customers who can unlock new benefits and productivity gains.

To combat this, Alphabet is increasingly committing more and more resources to building its own place in this burgeoning market, as evidenced by its commitment to continue to spend in larger quantities to do so; greater capex is to be expected for success against the incumbent. Alphabet’s executives, for their part, seem to be asserting⁴ that the company’s upcoming model Gemini will be more powerful than Microsoft/OpenAI-affiliated ChatGPT 4 while holding forth that delivering the “world’s most advanced, safe, and responsible AI” is now the company’s number one priority.

Whether the service offering can be deemed substantively better than that by the likes of Microsoft, of course, remains to be seen.

In Conclusion

In its present business model, the company has hit peak growth and is now entirely stable. Given the preponderance of ad spends, it can also be assumed that the company has now gone from “growth champion” in investor expectations to a “bellwether” of the macroeconomic outlook.

The AI edge could be a game-changer but there’s a lot of ground to cover, especially given that other giants (and possibly some other small-yet-mighty upstarts) are deep in the fray. While it’s likely that Microsoft will be recognizing substantial revenue upticks as a result of its mostly-matured and effective AI-integrated offering from 2024 onwards, Alphabet still has a ways to go. Market share capture (if any) in this key battleground would likely be visible from 2025 onwards.

Until the dust settles, the stock can be expected to shed some of its more ambitious pricing levels: such is the plight of a “bellwether” in this economy.

Footnotes:

1. “Alphabet Shares Fall After Search Revenue Misses Estimates”, 31 January 2024, Bloomberg
2. “UPS to Cut 12,000 Jobs as Wages Rise and Package Volumes Fall”, 30 January 2024, New York Times
3. “4 Key Takeaways From Microsoft’s Earnings Call”, 30 January 2024, Investopedia
4. “Leaked Google Memo Shows Aimless Execs Basically Worshiping AI”, 27 January 2024, Yahoo! News