– Chris Demasi
Last week Alphabet, the parent company of Google, released its financial results for the final quarter and full year of 2019. For the first time management disclosed the revenue contribution of two key growth engines of the company: YouTube and Google Cloud. While the new disclosure is still limited, it gives us a glimpse into the power of these businesses, which until now had been completely hidden.
YouTube comes to our screens
Prior to last week’s financial report, revenues generated from Alphabet’s Google advertising business had only been split between ad money earned from Google properties and that made from advertising across third-party, or Network Members, properties. The expanded revenue disclosures separate YouTube’s ad revenues from the rest of Google properties, which is dominated by the Search business. This is shown for the prior three financial years below.
Alphabet’s expanded revenue disclosure: YouTube
Source: Company filings
The power of the Google advertising business is immediately striking. In aggregate Search (and all the other Google properties), YouTube ads, and third-party sites generated $135 billion of revenues last year and increased 16% from the year before. The composition of the business and its growth is even more interesting.
Clearly Google’s own properties have been the most important revenue driver of the advertising business. They have accounted for over 80% of advertising revenues and a higher share of growth in the last three years. While Search is a big part of this given its sheer size approaching $100 billion in revenue, its growth rate has been moderating, from 22% in 2018 to 15% in 2019. YouTube ads have picked up the slack.
Since 2017 YouTube ad revenues have almost doubled to over US$15 billion. In the last two years YouTube has maintained a growth rate in the mid-30% range even as Search growth has tapered, making YouTube more and more important. In 2019 YouTube drove 22% of the advertising business’ growth compared to 14% in 2018. On a dollar basis the result is even more impressive. YouTube grew by US$4 billion last year, lapping a $3 billion increase the year before. There’s no sign of this stopping.
On the results conference call Alphabet’s CEO Sundar Pichai described the opportunity for YouTube to keep growing with advertiser customers:
“On the question on YouTube I do think there is a lot of opportunity ahead…it’s a platform working at scale…I think direct response is a huge growth area for us. And increasingly, I think when you look at the fact that people are consuming a lot of goods and services as part of their experience in YouTube, how can we create better commerce experiences also is a big opportunity for us….I think there is significantly more room over the mid- to long-term on monetization levels. And so, I think we see that is a big opportunity and are investing for it”
With a bigger base and the potential to keep growing rapidly, we can see YouTube adding even more to Google’s advertising revenues next year and propelling the advertising business forward for many years to come.
Google Cloud becomes less clouded
In addition to the extra disclosure on YouTube, Alphabet management also provided greater transparency on the Google Cloud business, which was separated out from the other revenue category. This is shown below.
Google Cloud revenues (US$m)
Source: Company filings
The additional disclosure affirmed our belief that Google’s cloud business, made up of G Suite productivity applications and Google Cloud Platform’s infrastructure and other cloud services, is scaling rapidly. Google Cloud revenues were almost US$9 billion in 2019 and ended the year with an annual revenue run rate above US$10 billion.
Impressively, while the business continues to gain the scale the revenue growth rate has not moderated – rather, it has accelerated! In 2018 revenues from cloud computing grew 44% and then in 2019 this rate of increase jumped to 53%, taking the dollar growth in from US$1.8 billion to US$3.1 billion. This has been driven by outstanding growth in the platform and analytics services.
While Google Cloud is playing catch up to Amazon’s AWS and Microsoft’s Azure it is gaining more than its fair share of new business in the market for cloud computing services. CEO Pichai attributes this to Alphabet’s unique ability to bring computer science capabilities across the group to its cloud customers and an expanded go-to-market approach that has seen the number of deals over US$50 million more than double. We suspect that Google Cloud remains around breakeven at the gross profit line today, but this will change dramatically in the next few years as rapid growth continues, and operating leverage is achieved on fixed data centre costs.
More growth engines
We have long believed that although Alphabet is dominated by Search (after all Google is a verb!) there are several other growth drivers beneath the hood of this wonderful company. The most recent report served to break out two of these and confirm our estimation that YouTube and Google Cloud are large, growing, and making greater contributions to the company’s overall expansion with a lot of runway ahead. We believe Alphabet’s stock price will continue to compound strongly as the market can more readily see these underlying growth drivers play out in the years ahead.
Christopher Demasi is a Portfolio Manager with Montaka Global Investments.
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