Ads, Cloud Computing Power Alphabet’s Strong Results

Wide-moat Alphabet beat expectations on the top and bottom-line in the second quarter.

Ad revenue continued strong double-digit growth as Google is monetizing its apps and the YouTube viewers more effectively.

We were impressed by the over 40% growth in other revenue, driven mainly by Google cloud and the consumer offerings.

We’re confident Google can leverage its proven technological expertise, including machine learning, to build and maintain public cloud platforms for various businesses. Its new cloud clients included Domino’s Pizza, PricewaterhouseCoopers, and SoundCloud.

On the margin front, gross margin is still being pressured by growth in traffic acquisition cost rates, higher spending on YouTube content, and the lower-margin hardware offerings. With lower gross margin and continuing increase in headcount and investments in R&D, we expect operating margin to be pressured impacting our fair value estimate of Alphabet, which is now $1,300 per share.

Last, the European Commission decided to fine Google $5.1 billion as it alleges Google is forcing smart phone OEMs to pre-install its apps. We think, whether that’s the case or not, consumers will keep downloading those apps. While there are no switching costs for users, the network effects of most of those apps will remain, especially given Google’s continuing improvement in search results. So, we expect demand for the apps to grow, forcing OEMs to place them on their devices as default, whether forced by Google or not.