Here’s what will propel Alphabet toward more growth after the pandemic

Published Thu, Apr 22 20212:05 PM EDT

Jennifer Elias @in/jennifer-elias-845b1130/

Key Points

Wall Street points to Google as a FAANG stand-out, citing progress in both core and non-core businesses.
Analysts say they can finally see the company's cloud business start to progress under CEO Thomas Kurian.
Returning ad sales and new features position Google to benefit from pandemic buying behaviors.

Alphabet 's stock hit an all-time high earlier this week, and analysts say growth in Google's businesses outside of search ads could propel shares even higher On Monday, April 19, the Google-parent company's stock price hit an intraday all-time high of $2,304.09 and ended the day at a record closing high of $2,289.76. But that's just the tip of the iceberg, analysts told CNBC. That's because the company is showing fresh ad dollars and non-core businesses growth, particularly in its cloud unit. Google Cloud brought in $13.06 billion in revenue in 2020, along with a hefty business backlog to boot. The company's recently revealed metrics from its Google Cloud division coupled with reaping benefits from more ad spend after the pandemic make it a stand-out. It comes nearly a year after having its worst ever quarter during the pandemic last fall. It also follows several years of failed attempts to gain market share in the subscription Cloud business. Alphabet's stock has been a standout among the FAANG stocks in recent weeks. Performing well during the most recent tech stock sell-off and rising about 28% year to date, compared with more than 6% for the Nasdaq-100, Google's parent is leaving its peers behind. In the last month, several banks have upped their valuations and buy ratings of the company. It's the first time, many say, they're starting to imagine a future less reliant on search ads, which make up the majority of the company's revenue. "Just three years ago, some of these businesses were still concepts and are now proving themselves out," said Gene Munster, managing partner at Loup Ventures. A pandemic 'dark horse' Some analysts say the company's fourth-quarter 2020 earnings surprised them. Ahead of next week's first-quarter 2021 earnings, investors say they expect Alphabet to be one of the largest beneficiaries of the pandemic recovery. Morgan Stanley, in a March research note, said Alphabet was "one of the more under-appreciated recovery names." In the fourth quarter of 2020, the company's search business growth returned to pre-pandemic levels, driven by online behavioral shifts. Alphabet's revenue grew 23% on an annualized basis in the quarter. That's stronger growth than the fourth quarter of the prior year, which came in at 17%. Bank of America also called the search giant a top reopening stock, citing a likelihood to see even higher revenue acceleration in the second quarter, "while many large-cap Internet company revenues are decelerating." Google-owned YouTube became the winner of the pandemic in terms of social media sites. The video platform saw usage grow from 73% of U.S. adults in 2019 to 81% in 2021, according to a Pew report . In 2020, YouTube showed 47% advertising growth from last year, thanks to direct-response ads. Direct-response advertising encourages consumers to act, such as buying an item from an e-commerce site or downloading an app. Analysts also point to travel and general economic spend returning. In some cases, such as with retail, spend is accelerating higher than even before the pandemic, according to an April analyst note from Mizuho Securities USA. "It's tough to find much fault with the stock," Newton Advisors founder and president Mark Newton told CNBC. Paid searches related to travel earnings, as well as sales and free cash flow, are all expected to grow between 19% and 24%, said Nancy Tengler, chief investment officer of Laffer Tengler Investments. "When the general economy is growing, Google's going to have greater growth because of the way it's structured with the marketplace and the bidding," Loup Ventures' Munster said. "Conversely, when things soften, it can have a greater negative impact, which we saw last year." Clouds parting Wall Street is finally starting to see the fruit of Google's labor in its cloud unit. Jefferies analysts in a recent note said the search giant's cloud business saw a sharper acceleration than Amazon's cloud unit Amazon Web Services. Even though Google Cloud reported an operating loss of $5.61 billion in 2020, it brought in $13.06 billion in revenue. The business unit has also been growing its backlog – a measure of demand from enterprises that have signed long-term agreements with Google Cloud. Indeed, deals over $250 million more than tripled from 2019 to 2020, according to Alphabet CEO Sundar Pichai. From 2019 to 2020, the cloud unit's overall backlog nearly tripled, chief financial officer Ruth Porat said in the recent quarterly earnings. JPMorgan valued the cloud business at $246 billion in an April note. Just three years ago, some of these businesses were still concepts and are now proving themselves out. managing partner, Loup Ventures Gene Munster Morningstar analyst Ali Mogharabi said he projects at least 32% annual growth over the next five years, adding that "the b2b potential makes the overall company a lot more attractive." "From a long-term perspective, it helps these guys become less dependent on advertising," he said. Oracle executive Thomas Kurian came to Google to lead its cloud efforts in 2019. Since then, the company has gone on hiring and acquisition sprees. Over the last two years with Kurian at the helm, revenue at the business unit is up 124%. Analysts say they expect Cloud to have first quarter losses similar to the final quarter of 2020, but they also predict revenue will rise. Streaming dreams closer to reality YouTube's growth, as big as it was in the recent quarter, hasn't even reached its monetization potential, analysts say. The online video platform's ad revenue popped 46% to $6.89 billion in the fourth quarter of 2020, thanks to direct-response ads. "YouTube is now best positioned to deliver on something we've talked about for a decade, which is two people watching the same live event, but getting different ads," Munster said. "That's an extremely valuable product for advertisers so there's massive potential there." Advertisers are more willing to look at non-television, and YouTube is the most prominent substitute, said Brian Wieser, president of business intelligence at firm GroupM. "There's no one that even comes close," he said. JPMorgan valued YouTube's business — which drives more than 10% of Alphabet's value — at $400 billion, according to an April analyst note. Google is ramping up its e-commerce efforts as the pandemic has created long-lasting demand for online buying. While analysts have been bearish in its ability to compete head-to-head with Amazon, they say there's enough of the e-commerce pie to go around — especially for YouTube. For starters, Google has been testing e-commerce features that analysts expect to be profitable. At the end of March, YouTube announced new feature experiments, which not only identify products in videos, but also consolidate a list of those items. The recommended algorithms could then show related videos as users scroll through the site. Credit Suisse estimated such offerings will help personalize ads and boost YouTube's monetization, which stands at about $9.80 per user per year, it calculated. That would help the company better compete against Facebook, which monetizes at three times that value at $30 per user per year. "This product potentially should help close that gap," Credit Suisse researchers said. "This increases the ability for YouTube to deliver more targeted ads and hence raises the value of existing ad inventory." Industry risks overshadowed Wall Street's optimism around Google's stock essentially pushes aside potential antitrust risks — at least, in the near term. Shares of Alphabet's stock rose modestly at the end of March, after Pichai participated in a congressional hearing on misinformation , alongside the heads of Facebook and Twitter. Google now faces several antitrust challenges around the world, including three government lawsuits filed in the U.S. in the last two months. But experts don't expect regulatory threats for another year or so. "I'd imagine an initial drop to the stock, but eventually it would improve within a few years," Munster said. Some even view a break-up as adding value to Google and its businesses. "We anticipate antitrust investigations to carry on with great fanfare this year and consumer privacy initiatives to grow; however, we believe the stock reflects these risks and Alphabet is worth more broken up than at its current valuation," said Brian J. White, an analyst with Monness, Crespi, Hardt & Co. In March, Google announced it would remove individual third-party cookie tracking in favor of group-based cohorts for its Chrome browser. The search giant began using a "privacy sandbox" that targets ads using the common interests shared by groups of people, as opposed to individual identifiers. Analysts said Google's new ad features won't just help it skirt potential industry headwinds, but it will likely boost the company's value. "Google will still participate in individual-level targeting when users are logged into their GOOG accounts, resulting in no impact on Search and YouTube targeting capability, said Oppenheimer, predicting the company could implement privacy changes on Android that are similar to Apple's impending iOS 14 update . "If Google is able to restrict alternative IDs, then Google just became even more powerful in the advertising industry," KeyBanc stated in a March note. It's a change that affects the entire ad industry — except for the search juggernaut, analysts say. That could complicate things. But, not enough to warrant worry from Wall Street just yet.