Alphabet (GOOGL 0.69%) seems like it should naturally lead in cloud business -- but somehow the opportunity slipped away. Alphabet's cloud business lost the initial cloud wars and now has significantly less heft today than Amazon's AWS and Microsoft's Azure. As a result, many investors feel that Alphabet has lost the ability to build a significant cloud business. However, here are three reasons Google's cloud business can outperform and eventually achieve profitability.
Contrary to popular belief, Google was not late to the cloud business -- it had developed a cloud business relatively early. Google launched Google App Engine (GAE) in 2008, only two years after Amazon developed Amazon Web Services (AWS). Some people even considered GAE technically superior to AWS. Yet AWS won the initial battles for market share. And maybe the most significant reason that GAE lost to AWS was that many developers didn't feel Alphabet was committed to building a cloud business.
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1. Trending toward the multicloud
In the early days of the cloud, most customers picked only one provider. However, the cloud has evolved over recent years from companies relying solely on a single cloud to using multiple ones. According to a 2020 Gartner survey of public cloud users, 81% of respondents used two or more providers. And the use of different clouds is growing for several reasons.
One, using multiple clouds lowers the risk of one provider having an outage. No company wants its business interrupted by services going down. A multicloud environment keeps business operations online; if one cloud fails, a company can quickly switch to another.
Second, since Microsoft threw its weight around in the 1990s with its monopoly Windows operating system, companies have detested relying only on one vendor for an essential piece of software. Google understands that companies don't want to be locked into only one cloud, and it has structured its platform to empower developers to build new software applications and run them on any cloud they choose.
Alphabet has many best-of-breed services that users pay for that can be used on any cloud. For example, customers can run Google's BigQuery analytics on data stored in Amazon S3 or Azure blob storage. Alphabet can still generate revenue from companies using other clouds.
2. Security is a big differentiator for Google
Cloud customers have become more interested in security since the 2020 Solarwinds hack breached the U.S. federal government.
At the same time that worries were rising about security after Solarwinds, Forrester Research released a report at the end of 2020 naming Google Cloud as a leader in Infrastructure-as-a-Service (IaaS) security. During a recent Deutsche Bank conference, Google Cloud CEO Thomas Kurian labeled Google's cloud security and tools a big differentiator for the company in gaining interest from potential customers.
Alphabet believes so much in security that it intends to buy security company Mandiant (MNDT). As a result, Google Cloud will have a tool its larger competitors lack. Mandiant, formerly FireEye, was the first company to detect the Solarwinds hack.
Investors are still skeptical of Google Cloud
Investors remain skeptical. Three years of Kurian's leadership have not helped Google Cloud close the gap in market share with AWS or Azure, which investors want to see. Also, Google Cloud remains unprofitable. However, the good news is that Google Cloud is growing close to 50% each year in a market that industry experts expect to grow at a compound annual growth rate of 19.1% to 2028, suggesting that the company's capturing market share from rivals.
Alphabet also is making progress toward profitability. For example, Google Cloud improved from $5.6 billion in operating losses in 2020 to losses of $3 billion in 2021.
Alphabet is a great way to invest in the cloud market. With the stock selling at just 19 times trailing earnings, compared to a five-year average P/E of 33, growth investors should consider an investment in the company.
