UPDATED 16:33 EDT / OCTOBER 25 2018

CLOUD

Amazon and Alphabet show strong cloud growth, but investors wanted more

Updated:

Cloud computing continues to make an outsized impact on advertising giant Alphabet Inc. and e-commerce goliath Amazon.com Inc., but it wasn’t quite enough in their latest quarters to boost revenue growth up to what investors hoped.

Still, the two tech giants’ third-quarter cloud results signal that the move by companies to rent computing power and applications online rather than host hardware and software in their own data centers shows little sign of slowing down. Amazon, for one, attributed its third-quarter upside in operating income partly to its cloud business.

Although it costs both companies billions of dollars to build massive data centers around the world, the cloud is also a highly lucrative subscription business. That’s why investors are keenly interested in how Alphabet-owned Google LLC’s cloud platform and Amazon Web Services Inc. are faring, even though revenues remain relatively small compared with their core businesses.

AWS revenue jumped 46 percent from a year ago, to $6.68 billion, a hair below consensus expectations of $6.71 billion. Overall, Amazon earned a profit of $2.9 billion in its third quarter, or $5.75 a share, up more than tenfold from a year ago. Revenue rose 29 percent, to $56.6 billion. Analysts had forecast a profit of $5.62 per share on revenue of $57.07 billion.

“AWS continues to be an earnings engine for the company,” said Charles King, principal analyst at Pund-IT Inc., pointing to the 77 percent jump in AWS operating profit. “To put that in perspective, while AWS was responsible for a bit over 10 percent of the company’s $56.6 billion in quarterly revenues, its profits accounted for more than a third of Amazon’s total net profit.”

Alphabet doesn’t report cloud revenue, though Chief Executive Sundar Pichai revealed early this year that it’s a billion-dollar-a-quarter business. And it’s the lion’s share of a segment that also includes Google Play store app, smartphone and smart speaker revenues. That segment rose 29 percent in the third quarter from a year ago, to $4.6 billion.

Alphabet overall saw its third-quarter profit rise 37 percent, to $9.2 billion, or $13.06 a share, on a 21 percent increase in revenue, to $33.7 billion. Analysts had expected a profit of $10.44 a share on $34.05 billion in revenue. Chief Financial Officer Ruth Porat said on the analyst conference call that currency adjustment caused a negative impact on sales of $305 million after hedging.

Investors disappointed

Investors wanted to see more revenue growth from both companies, however. In after-hours trading, Amazon’s shares were falling almost 8 percent, while Alphabet’s were down about 4 percent. Update: On a volatile Friday, when the tech-heavy Nasdaq index fell about 2 percent, Amazon stock slumped nearly 8 percent, but Alphabet shares fell less than 2 percent.

Amazon’s stock also may have been affected by the seemingly muted fourth-quarter guidance of a 10 to 20 percent rise in fourth-quarter sales, to between $66.5 billion and $72.5 billion. It also forecasts operating income of $2.1 billion to $3.6 billion, compared with $2.1 billion the year before, but analysts were reckoning $3.86 billion. “That’s a critical point since holiday sales have long been a goldmine for Amazon,” said King.

Given that the fourth quarter is usually the highest-margin quarter and higher-margin businesses such as AWS and ads are growing quickly, Cowen & Co. analyst John Blackledge wrote in a note to clients that “the operating income guide is likely conservative,” and he thinks profit likely will end up at the high end of the forecast.

Like a lot of tech stocks, both companies shares have been on a roller coaster lately. Amazon’s stock fell almost 6 percent Wednesday, to 1,664.20, leaving it down 15 percent from a recent high of $2,050.50 Sept. 4, but still up 46 percent on the year. Today it closed up more than 7 percent, to $1,782.17. Alphabet’s shares fell more than 5 percent Wednesday, to $1,057.12, down about 15 percent from a July high, but recovered today to rise more than 4 percent, to $1,103.59.

Despite Google’s gains in the cloud, Amazon remains the king of cloud computing, at least for the base-level infrastructure-as-a-service computing, storage and networking services. But both companies are also facing a rejuvenated Microsoft Corp., the No. 2 cloud player. On Wednesday, the software giant reported its cloud revenue growth is slowing, but it was still 76 percent, meaning it’s gaining share on both its main rivals.

Pichai said Google’s cloud business is benefiting from a constant addition of new services. “We’re definitely seeing strong indicators that the investment in product is clearly beginning to work,” he said. “We’re very aligned with where the market is headed in the long run,” in particular the reality that companies will be using multiple public clouds.

He also said it’s “thoughtfully looking” at a more comprehensive hybrid-cloud strategy that includes more connections with customers’ on-premises infrastructure — a strategy where Microsoft has seen a lot of success — but is addressing that for now through partners such as SAP SE and VMware Inc. “We are thinking about how to do it better,” he said. “I don’t see it as a gating issue for us.”

Analyst King called Google Cloud a work in progress. “That’s not necessarily a bad thing since the company has been able to avoid high profile slugfests, like the one happening between AWS and Microsoft Azure,” he said. “That also gives Alphabet some relative peace and quiet to build out its cloud business organically during what most people consider a still evolving cloud computing market.”

But other analysts want to see nearer-term results. “Management is clearly focused on using AI/ML to differentiate its cloud and hardware business,” Macquarie Capital (USA) Inc. analyst Ben Schachter wrote in a note to clients. “This could be the correct strategy for the long term, but we’d like to see faster progress.”

Beyond the cloud

Google and Amazon are increasingly competing more directly not only in cloud computing but in Google’s traditional stronghold: advertising. Amazon reported “other” revenue of $2.5 billion — mostly advertising– were up 122 percent from a year ago and ahead of forecasts of $2.39 billion. And it has been making serious moves to expand its appeal to advertisers.

Google doesn’t appear to be feeling the heat just yet. Its ad revenue rose 20 percent, to nearly $29 billion. Facebook Inc. remains a more direct rival in ads. It’s scheduled to report its third-quarter results next Tuesday.

The two companies increasingly are competing on hardware as well, in particular, smart speakers that include Amazon’s Echo and Google’s Home lines. Although Porat said hardware was a relatively small contributor in the third quarter because of very recent introductions of smartphones and home devices, Pichai said, “Our hardware efforts are picking up great momentum.”

Alphabet’s “Other Bets,” which mostly come from its Fiber internet access unit and its healthcare company Verily but also include the self-driving car firm Waymo, Nest home devices unit and other businesses, logged an operating loss of $727 million, up from $650 million a year ago, on revenue of $146 million, up from $117 million a year ago.

Google’s results were overshadowed somewhat by the latest in a stream of controversies, including allegations in today’s story in The New York Times that former Android chief Andy Rubin had left because of several sexual misconduct allegations while getting $90 million in departure payments.

Image: Haseeb Jamil/Unsplash

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