Google Cloud Summit: A Preview of Google Cloud Margin Expectations

Alphabet Inc.’s (NASDAQ: GOOGL) Google Cloud CEO, Thomas Kurian, shared his thoughts on AI innovation at the Google Cloud Summit. Kurian emphasized the importance of supporting startups and highlighted several ways Google Cloud is doing this. He highlighted that Google Cloud is giving startups focused on building foundational models access, both, to the entire technology stack and the developer ecosystem. Kurian noted that it is not simply the chips, but also the software layer that is helpful and of interest to startups. He explained that there are a number of startups building applications on the platform. This should be a longer-term positive for Google Cloud’s growth.

Since last year, Alphabet has shifted gears on its AI strategy. Google Cloud has continued to show improvements. However, the size and profitability of Google Cloud still trails AWS and Azure.  While innovations in the chips and the models have excited the market about the potential for GenerativeAI (GAI) applications, there has not been much innovation for the end user. Will startups drive the next generation of GAI applications and growth for Google Cloud?

Google Cloud CMO Alison Wagonfeld with CEO Thomas Kurian at Google Cloud Summit ‘24

Source: Google Cloud Summit (October 8, 2024)
https://cloudonair.withgoogle.com/events/summit-startup-24

Operating Margin Expectations

One of the key aspects of the Alphabet investment story is that Google Cloud continues to improve its operating profit margin. This business broke even and generated a 5.2% operating profit margin in FY 2023, or $33 billion in revenue and $1.7 billion in operating profit. Based on Visible Alpha consensus, Google Cloud is now expected to generate a 10.4% operating margin, up from 9.8% in July in Q3 2024. By the end of FY 2024, consensus now expects an 11% operating profit margin, or $4.7 billion in operating income on $42 billion in revenue. However, there is some debate about the Google Cloud business, with operating profit estimates ranging from $3.8 billion to $5.8 billion. Longer term, Google Cloud is expected to achieve a 15.5% operating profit margin by the end of FY 2026.

While the margin improvement for Google Cloud was positive in FY 2023 and H1 of FY 2024, it remains far from the profitability of the company’s main Cloud competitors. Microsoft delivered a 45.1% operating profit margin in its Intelligent Cloud business and Amazon’s AWS segment generated a 35.5% margin last quarter. However, it is worth noting that both Microsoft Intelligent Cloud and Amazon AWS are each expected to see margins pull back going forward, according to Visible Alpha consensus.

The Google Cloud innovations supporting startups are designed to add value to the user’s existing workflows by helping to make the user more efficient and productive with their existing tools. However, it is unclear how long it will take for these AI product innovations to drive revenues and profitability in the Google Cloud business segment, especially among small enterprise and individual users. Google Cloud will need to deepen its monetization with all users to move the needle meaningfully on operating profit, which may prove challenging given AWS and Azure’s size and profitability in cloud and legacy tools.

Google Cloud Consensus Estimates

Source: Visible Alpha consensus (October 8, 2024). Stock price data courtesy of FactSet.
Alphabet’s current stock price is as of the market close on October 7, 2024

Alphabet’s Key Financial Items

Source: Visible Alpha consensus (October 8, 2024). Stock price data courtesy of FactSet.
Alphabet’s current stock price is as of the market close on October 7, 2024

Final Thoughts

The development and adoption of GAI is in its infancy, but evolving quickly. Google Cloud seems poised to benefit from this technology shift. However, how the profitability of this business will ultimately shake out will be a critical long-term investment question for the stock. Will Google Cloud be able to carve out a more profitable place in the cloud landscape and move more quickly toward the 27% margin Amazon achieved last year for AWS?