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Forget Google’s Advertising Business, Cloud Is Where It’s At

By Nicholas Rossolillo - Feb 4, 2020 at 3:09PM

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The Alphabet segment is getting new attention, and it's clear it is catching up to the biggest names on the block.

By all counts, Alphabet (GOOGL 5.11%)(GOOG 5.20%) had an awesome finish to 2019. Full-year revenues increased 18% to $161.9 billion, earnings per share increased 12% to $49.16, and free cash flow (revenue less operating and capital expenses, the end-all and be-all of bottom-line profits) surged 45% to $30.97 billion.

Within the greater context of the juggernaut that is Alphabet, though, it's the cloud segment that's really exciting. Often drowned out by the louder first and second fiddles Amazon's (AMZN 3.58%) Amazon Web Services (AWS) and Microsoft's (MSFT 3.42%) Azure, Google Cloud is surging and catching up fast, according to new segment details Alphabet is providing.

A man in the background pressing a web browser search bar in the foreground.

Image source: Getty Images.

Google's "small" segment that could

During 2019, the Google Cloud segment generated $8.92 billion in revenue. In the fourth quarter alone, Cloud grew 53% to $2.61 billion. Not exactly a small business, but small compared to the internet search company's total sales, which are still dominated by advertising revenue.  

Likely for this reason, it wasn't until this last Q4 report that Alphabet started breaking out Cloud from its "Other Revenues" segment -- a mashup of businesses including Pixel and Nest hardware and the Google Play application store. It's good they did this since Google Cloud is growing so fast, more than doubling in size the past three years and becoming an ever-greater chunk of the whole.  

Alphabet Segment

2017

2018

2019

Google Cloud

$4.06 billion

$5.84 billion

$8.92 billion

Total revenue

$111 billion

$137 billion

$162 billion

Google Cloud as percentage of total

3.7%

4.3%

5.5%

Data source: Alphabet.  

It's a small piece of the Alphabet pie, but the growth in cloud is significant. It's an incredibly profitable business model that only gets more lucrative with scale. Cases in point: AWS and Azure, both of which are helping their parent companies generate big profits. 

A cash-generating machine

In Amazon's 2019 Q4, AWS grew 34% year over year to $9.95 billion, generating an operating profit margin of 26.1%. AWS also accounted for 67% of Amazon's operating income in the period. As for Microsoft, its cloud segment (which includes Azure, Office 365, and other cloud business) grew 27% year over year in its last quarter to $11.9 billion. Microsoft doesn't break out specific operating margin results by segment, but the various cloud products helped the software company create a 35% increase in operating profit on a 14% gain in total revenue during the final quarter of 2019.

For now, Google Cloud likely isn't as profitable as its larger peers; Google brass during the quarterly conference call said it is investing heavily in the segment, including hiring new talent and dumping cash into research and development. But that will change as it grows and should be a meaningful contributor to cash flow over time -- not to mention feed into growth strategies in Alphabet's other assets, like the Verily healthcare and Waymo autonomous vehicle subsidiaries.

Cloud computing is by no means new, but it's still a fast-growing industry and looks like it will be in high-octane mode for another decade or so. Though it's far smaller than its peers, Google Cloud is catching up and is a key component of Alphabet that's worth watching each quarter, now that the company provides more detail on what's going on under the hood.

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