Alphabet (GOOG 1.25%) (GOOGL 1.27%) relies heavily on advertising revenue, but has expanded its business into the growing cloud computing market, where IBM (IBM 0.16%) also plays. The cloud is an exciting segment, but that didn't help these tech titans avoid the impact of the COVID-19 pandemic. Has one been hit harder? Is one a better investment? Let's look at each to determine the answers.
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IBM's cloud success
IBM was well on its way to repositioning its business around cloud computing services when the pandemic struck. Last year, it acquired open-source cloud computing platform Red Hat and in April, the company appointed the head of its cloud and cognitive software division, Arvind Krishna, as the new CEO. The percentage of revenue coming from cloud computing grew from 4% in 2013 to 27% in 2019.
IBM focuses specifically on the hybrid cloud market. There are public clouds, where a third party owns computing resources, such as servers, and shares them with different businesses. And there are private clouds, where computing resources are dedicated to a single business. Hybrid clouds combine a public cloud's lower IT infrastructure costs with the security and control of a private cloud.
Hybrid cloud solutions are ideal for industries such as banks, healthcare, telcos, and government, which are the industries where IBM generates the majority of its revenue. Because cloud security is important to these areas, IBM recently acquired Spanugo, a cloud security company.
IBM's efforts are paying off. Cloud computing revenue grew to $5.4 billion in the first quarter, a 19% year-over-year increase. Moreover, the company's secret weapon is its long-standing work with artificial intelligence (AI). Its clients need help managing and making sense of the data troves stored in the cloud and used in business, which AI is equipped to do.
Overall Q1 revenue was down 3.4% to $17.6 billion as clients reevaluated spending needs due to the pandemic. Still, the company possesses solid financials. IBM's cash position of $11.2 billion at the end of the first quarter, up from the previous quarter's $8.2 billion, and free cash flow of $1.4 billion position it to weather an economic downturn.
Alphabet's ad dependency
Alphabet's Google Cloud division grew 52% in the first quarter despite the pandemic, but it still accounted for only $2.8 billion of the company's $41.2 billion in Q1 revenue.
Although Alphabet's non-advertising revenue has grown over the years thanks to offerings such as Google Cloud, the organization is still heavily reliant on advertising. Over 80% of its first-quarter revenue came from advertising. This dependency creates challenges in the COVID-19 pandemic, which caused the advertising industry to pull back its spend dramatically during the first quarter.
Alphabet's Google search generated $24.5 billion, over 70%, of the ad revenue, and according to CFO Ruth Porat, this part of the business experienced a year-over-year revenue decline in the mid-teens in March, revealing the extent of the advertising decline. The company's Q1 revenue still enjoyed a 13% year-over-year increase, but subsequent quarters are likely to see year-over-year revenue declines until the global economy recovers.
Cloud computing isn't Alphabet's only bright spot. Porat indicated YouTube's March ad revenue declined only by single digits year over year, better than the company's core search business. YouTube's ad revenue ended the quarter with a 33% increase to $4 billion from $3 billion in 2019.
YouTube's resiliency lies in consumer adoption of internet-enabled streaming television programming. Streaming media consumption grew as consumers remained sheltered at home. The pandemic accelerated a shift that had been occurring.
Television ad spend accounted for over $70 billion in the U.S. last year. With more consumers watching streaming media on services such as YouTube, Alphabet is poised to capture some of that television budget as it shifts to digital outlets.
The bottom line
In the short term, IBM's cloud-focused business appears more resilient than Alphabet's ad-dependent one. Another factor in IBM's favor is its dividend and high yield, currently at 5.56%. The company raised its dividend in April, the 25th consecutive year of increases. Alphabet doesn't pay a dividend.
However, over the long run, Alphabet's position will strengthen as advertising returns to normal. If it captures a greater share of television budgets and continues to grow its Google Cloud revenue, Alphabet stock becomes even more appealing.
So the bottom line is this: If you're an income investor or looking for stability and predictability, IBM is the stock for you. These qualities also make it a good choice for your retirement account. If you're a growth investor willing to wait out the pandemic's impact, Alphabet is the one for you.
