Alphabet (GOOG -1.94%) (GOOGL -2.03%), the parent company of Google, posted its first-quarter report on Tuesday, April 25. The tech giant's revenue rose 3% year over year to $69.8 billion and beat analysts' estimates by $950 million. Its net income fell 8% to $15.05 billion, or $1.17 per share, but cleared the consensus forecast by $0.10.
Alphabet's stock rose slightly during after-hours trading following that report, but it remains nearly 30% below its all-time high from November 2021. Will the market stay bearish on the tech giant's near-term prospects, or will the bulls finally prevail?
Image source: Getty Images.
Reviewing Alphabet's key numbers
Alphabet generated 79% of its revenue from Google's advertising platforms (including its search engine and YouTube) in the first quarter. Google Cloud accounted for 11% of its revenue, while the rest mainly came from Google's "other" businesses like paid subscriptions and hardware devices. Here's how those three segments fared over the past year.
|
Metric |
Q1 2022 |
Q2 2022 |
Q3 2022 |
Q4 2022 |
Q1 2023 |
|---|---|---|---|---|---|
|
Google advertising revenue growth (YOY) |
22% |
12% |
3% |
(4%) |
0% |
|
Google other revenue growth (YOY) |
5% |
(1%) |
2% |
8% |
9% |
|
Google Cloud revenue growth (YOY) |
44% |
36% |
38% |
32% |
28% |
|
Total revenue growth (YOY) |
23% |
21% |
6% |
1% |
3% |
Data source: Alphabet. YOY = year over year.
The macro headwinds forced businesses to rein in their spending on both ads and cloud software deals, which dealt a one-two punch to Alphabet's two largest segments. Currency headwinds exacerbated that pressure by reducing its total revenue growth by 4 percentage points in 2022 and 3 percentage points in the first quarter of 2023.
To counter that slowdown, Alphabet is cutting costs and is currently in the process of laying off about 12,000 employees, or 6% of its workforce, throughout the first half of 2023. Its operating margin still dropped 5 percentage points year over year to 25% in Q1, but that represented a 1-percentage-point improvement from the previous quarter.
Alphabet also authorized a new $70 billion buyback for its Class A and C shares, which would be equivalent to about 5% of its current market cap if fully executed. Those buybacks might complement its cost-cutting measures and boost its EPS.
What the bears will tell you
The bears believe Alphabet's problems aren't merely cyclical. They'll point out that YouTube's advertising revenue still slumped 3% year over year in Q1, marking the streaming video platform's third consecutive quarter of declining ad revenue. Some of that slowdown was likely caused by macro headwinds, but YouTube also faces fierce competition from ByteDance's TikTok and Meta Platforms' Reels.
The bears also expect Google's core search engine to face intense competition from generative AI platforms like OpenAI's ChatGPT and Microsoft's Bing Chat in the near future. Google has been pushing back with its own AI-powered Bard chatbot, but this paradigm shift could eventually disrupt its advertising business.
Google also pays Samsung and Apple, the two largest smartphone makers in the world, billions of dollars annually to remain the default search engine for their devices. But some recent rumors suggest Samsung might replace Google with Bing -- and that Apple could capitalize on the conflict by squeezing higher fees out of Google.
Finally, Google Cloud only held 10% of the cloud infrastructure market in the fourth quarter of 2022, according to Canalys. Amazon Web Services (AWS) and Microsoft's Azure led the market with 32% and 23% shares, respectively. It could be tough to catch up to those two rivals without crushing its own margins.
What the bulls will tell you
The bulls will point out that Alphabet expects to face milder currency headwinds this year, and the growth of its advertising business is stabilizing on a year-over-year basis. Furthermore, Google's ongoing expansion of YouTube's subscription tiers for YouTube TV and YouTube Music Premium -- which caused its "other" revenue to accelerate over the past year -- could offset the persistent headwinds for its advertising business.
Google is also still the world's largest search engine, so it could leverage that market dominance -- along with the rest of its sprawling ecosystem of services -- to adapt to the evolving search market and prevent ChatGPT, Bing Chat, and other generative AI challengers from gaining ground. As for Google Cloud, the segment actually generated an operating profit of $191 million in the first quarter, compared to an operating loss of $706 million a year earlier, which indicates it still has the scale and pricing power to keep pace with AWS and Azure at a profitable pace.
Last but not least, Alphabet is still the cheapest FAANG stock at 19 times forward earnings. Analysts expect its revenue and earnings to grow 6% and 11%, respectively, this year, so its current challenges seem temporary instead of existential.
Which argument makes more sense?
Alphabet has been a disappointing investment over the past year, but I believe it will overcome its near-term struggles by trimming the fat and focusing on its long-term priorities. Investors who tune out the noise and buy some shares now should be well rewarded as the tech giant evolves with its industry peers over the next few years.
