Alphabet earnings: Google hardware push should boost non-advertising business

At its core, Alphabet Inc. is a company driven by advertising, but executives have developed or acquired a substantial portfolio of other businesses that bet on different industries and will be especially important in its fourth-quarter earnings report.

For the most part, Alphabet’s GOOGL, -0.09%GOOG, -0.02% non-ad revenue is combined into one major line item: “Google Other.” It’s a broad category of business lines that include app-store revenue; sales of its own hardware, which Google refreshed at a San Francisco event in October; and Google Cloud Platform, which executives say is a big contributor.

Analysts polled by FactSet project the category will be a $14.2 billion business in 2017, up from $10.1 billion the year earlier, and rise to $18.42 billion in 2018. Executives will likely provide some level of detail about non-advertising sales on the fourth-quarter earnings call, scheduled for Thursday after the close; in Alphabet’s last earnings conference call, Chief Financial Officer Ruth Porat said that GCP was the largest contributor to the “Other” revenue bucket, and is on track to hit an annual run rate of more than $10 billion.

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For cloud computing, one of the ways Alphabet seeks to differentiate itself from the likes of Amazon.com Inc. AMZN, +1.11% and Microsoft Corp. MSFT, -0.15% is its deployment of artificial intelligence. Chief Executive Sundar Pichai has said Google has aimed to be an AI-first business across all its products since at least 2016, and for GCP that has meant offering AI technology as a service.

“Our focal points, are really centered around democratizing AI, and facilitating data-driven transformations of companies,” Google Cloud President Tariq Shaukat told MarketWatch late last year. “When we talk about democratizing machine learning and democratizing AI more broadly, the focus we have from a product standpoint is really how do you take companies that don’t have the 100 Ph.D.’s from whatever university focused on deep learning and machine learning; how do you take those companies and make this journey accessible to them?”

Like Cloud, the company’s gadget pitch also invokes AI. At the San Francisco launch event, executives said the company’s hardware was designed to fully leverage the software, often cloud-based, that powers devices. Google Assistant, for example, uses a phone’s mics coupled with speech recognition and vast search-related databases, among other products. The company’s Home series of smart speakers was thought to be a big seller in holiday shopping, and its Pixel 2 smartphone went on sale during the quarter.

Next to the mobile phone, where Apple has made its fortune, and the smart speakers that Amazon has helped develop into a nascent market, Google has developed a suite of other computing products that listen, watch and accept inputs. Whether that suite of products — which includes a high-end laptop, a virtual-reality mount for smartphones and wireless earbuds — will take off is a question executives can expect to hear Thursday.

What to expect

Earnings: On average, analysts polled by FactSet model earnings of $10 a share and adjusted earnings of $11.97. Contributors to Estimize, which crowdsources estimates from analysts, fund managers and academics, predict earnings of $10.28.

Revenue: Four the fourth quarter, analysts predict sales of $25.58 billion after accounting for traffic-acquisition costs. Analysts estimate TAC costs of $6.27 billion in the fourth quarter. Other bets, Alphabet’s division that houses experimental businesses such as self-driving company Waymo, is expected to haul in $355 million in fourth-quarter sales. Estimize contributors model overall Alphabet sales of $25.76 billion, without TAC.

Stock movement: Alphabet class A stock is up 19% in the past three months, and 38% in the past year. The benchmark S&P 500 index SPX, -0.67% rose 11% in the past three months, and 24% over the past year.

Of the 43 analysts that cover Alphabet, 37 rate the stock the equivalent of a buy and six rate it a hold, according to FactSet. The average price target is $1,224.12, reflecting 3.2% upside from Monday’s closing price.

What else to watch for

When talking about Alphabet’s finances, it’s impossible to avoid traffic-acquisition costs. GBH Insights head of research Daniel Ives wrote in a December note to clients that TAC trends will improve through 2018, Despite an increase in the most recently reported quarter, largely driven by mobile search trends. Mobile advertising, Ives wrote, is the most important ad revenue driver into 2018. Ives rates Alphabet the equivalent of a buy with an $1,190 price target.

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Alphabet-owned Google and its wildly lucrative Adwords business looks in no danger of slowing down, analyst Shyam Patil of Susquehana Financial Group wrote in a January note to clients. As is often the case during the December quarter, retailers and others ramp up ad spending to capture more holiday shopping dollars — which likely means Google’s inventory prices went up. Even though Google didn’t implement any major overhauls to its ad tech platform in 2017, the cumulative benefits of minor changes “modestly” increased ad spending, Patil wrote.

Ads for product listings have come under threat from Amazon, which is increasingly used as the default starting point for internet-based shopping. Regardless, growth in ads for product listings is greater than overall ad spending increases, Patil wrote. Patil has the equivalent of a buy on the stock with a $1,250 price target.

Much like Facebook Inc.FB, -2.12% , Alphabet is chasing lucrative television ad dollars through its video properties. Though the company does not break out revenue or other detailed financial indicators for YouTube, analysts have estimated the unit will haul in more than $12 billion in 2018 sales on the low end.

Last week, Alphabet also announced that it was launching a cybersecurity company called Chronicle LLC, which was developed inside the company’s secretive X lab. The new unit is part of the company’s broad strategy to make a number of smaller bets in the hopes that one will become a significant business. Other efforts include self-driving vehicle unit Waymo; DeepMind, an artificial intelligence-business; and acquisitions such as thermostat maker Next.

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