Will Google Cloud Revenue Growth Dip Further? Analyst Sounds Alarm on Growth Trends

Mizuho analyst James Lee reiterated a Buy rating on Google parent Alphabet Inc GOOGL with a price target of $155.

After reviewing critical operating metrics, he noted that the Street is optimistic about cloud revenue growth and operating margins. 

For cloud, his AWS case study of cost optimization indicates that Google Cloud’s revenue growth could further decline in the foreseeable future, leading to downside vs. Street expectations. 

Based on a case study of Amazon.Com Inc AMZN AWS’ cost optimization process, including moving from spot to long-term contracts, downgrading products from premium to basic, and shifting to services processed by advanced chips, Lee noted that Google Cloud revenue growth could still be facing decelerating trends, increasing the likelihood of revision risk. 

Despite facing easy comps, AWS went through 6 quarters of deceleration during its cost-optimization cycle. As a comparison, Google Cloud has gone through 4 quarters so far, so he expects at least a quarter or two more to go before stabilizing. Lee modeled 4Q23 Google Cloud revenue growth at 21% YoY, 3 points below consensus. 

For operating expenditure, Lee noted that consensus has yet to fully reflect headwinds related to NFL Sunday Ticket licensing costs and potential legal expenses in 4Q23. 

At the same time, margin expansion for FY24 could be limited, given continued investment in AI. With that in mind, the analyst could see potential negative earnings revisions. Lee noted that consensus opex expectations appear to be optimistic at only 10 bps of increase from last quarter to 6.4% due to the licensing costs of NFL Sunday Ticket and accrued legal expenses.

For the NFL, licensing expenses are incurred based on games played rather than on a straight-line basis. As a result, Lee expects to recognize 50% of the annual costs in 4Q23, which leads to 80 bps of headwinds on the operating margin. For legal fees, the company accrued nearly $600 million of expenses in 3Q23 for ongoing trials. As these cases continue into 4Q23, he sees an increased likelihood of additional legal expenses accruing during the quarter. With that in mind, the analyst looks for opex to grow 7.0% YoY and OPM of 26%, compared to the consensus of 28%. As a result, his 4Q23 OPI forecast is 7% below the Street. However, fundamentals remain intact long-term.

Lee projected Q4 revenue and EPS of $84.06 billion (consensus $85.12 billion) and $1.46 (consensus $1.59).

Price Action: GOOGL shares traded lower by 2.32% at $128.80 on the last check Monday.