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What Is Alphabet Spending Its Money on in 2016?

By Adam Levy - Feb 18, 2016 at 10:30AM

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Capital expenditures are expected to climb again in 2016.

Image source: Alphabet

Ever since Ruth Porat took over as Alphabet's (GOOG -0.27%) (GOOGL -0.21%) CFO, capital expenditures at the company have gone down every quarter. In 2015, total capital expenditures fell 14% for the company.

While Alphabet stepped on the brakes last year, Microsoft (MSFT 1.07%) increased its capex spending 19%. Amazon (AMZN 3.15%) maintained its level of capital expenditures, declining about 2% after increasing spending more than four-fold over the previous four years.

Alphabet still spends much more than its competitors on capex, but it has its hands on quite a few more capital-intensive projects. On Alphabet's fourth-quarter earnings call, Porat told analysts that they can expect "to see accelerated investment in capex" this year. So where can investors expect Google to spend its money this year?

To the cloud
The vast majority of Alphabet's capex goes to support Google. In particular, Google needs lots of computing capacity to support the millions of search queries, emails, YouTube videos, and other data it sends and receives every minute. The company also has a growing enterprise business selling various cloud platforms to other businesses, but it's still lagging Microsoft and Amazon.

Amazon's AWS is a nearly $10 billion business, bringing in $2.4 billion in revenue in the fourth quarter. Microsoft obscures its cloud platform business by throwing in its own cloud services into its reporting segment. The company provided one small detail, noting Azure -- its cloud platform -- grew revenue 127% in the fourth quarter.

Google is well behind those two giants. A recent survey from RightScale found that just 10% of businesses use Google's cloud services with another 31% either experimenting with them or planning to use them. In contrast, 20% of businesses use Azure and a whopping 57% use AWS. Forty-four percent are considering Azure, and 25% are considering adding AWS.

Investors should expect Alphabet to increase its capital expenditures on computing power not only to support Google's consumer services, but to increase its capacity to grow its cloud business.

Don't forget your Fiber
Another area requiring large capital expenditures is Alphabet's Fiber business. Fiber currently provides gigabit Internet speeds in four metro areas with planned expansions to five more. Eleven more cities are under consideration. Fiber incurs a lot of expenses in its early stages, as the business must build its network of physical fiber-optic cable. Porat noted that capital expenditures on Other Bets are primarily used to support Fiber.

Fiber was one of the biggest revenue drivers for Alphabet's Other Bets segment. Other Bets generated just $448 million last year, less than 1% of Alphabet's total revenue. Meanwhile, capital expenditures for Other Bets totalled $869 million last year, 9% of the company's total. Moreover, capex for Other Bets grew 73% last year compared to the 37% growth in revenue.

Alphabet needs to accelerate its revenue growth for Fiber and the rest of its Other Bets to support the large amounts it's investing in capital expenditures. While management has made comments in the past that it expects Fiber to become a profitable business (and it's not just doing this to spur on other Internet service providers), the early investments have yet to pay off. If Other Bets continues to drag, investors may demand more details about what's going on in the segment.

While Alphabet may spend some money on capital expenditures for a few other businesses, Google and Fiber will make up most of the company's planned expenses. Investors should expect total spending to increase again in 2016, despite the lull last year. Net profit margin may decline, but Google is planning for growth this year and needs to spend the capital to support it.

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