Authored By Louis Stevens
In September of 2023, I published a Brief entitled, "The Third Supermajor." At the time, Google Cloud generated just $8B in quarterly sales and just $400M in operating income, which you can see in the 10-Q excerpt below:
Alphabet's Google Cloud Sales (Q2'23 10-Q)
Today, I will share an update to Alphabet's GCP performance and share some general thoughts about the business as well.
The term Supermajor refers to the largest cloud businesses on earth: AWS (AMZN), Azure (MSFT), and GCP (GOOG). I understand that these are commonly referred to as the hyperscalers but:
- Investing is all about independent thought, and I do not believe hyperscalers is a good long term moniker for these businesses, as I will elaborate in a moment.
- The concept of being a Supermajor is simply a more accurate descriptor of these three businesses. Lots of things have and will hyperscale, e.g., but very things become Supermajors, vertically integrating their entire industries in the process.
The term Supermajor originated in the 20th century during which Exxon Mobil (XOM), Chevron (CVX), and Royal Dutch Shell (RDS) vertically integrated the upstream, midstream, and downstream aspects of the oil and gas value chain. In the 21st century, data is referred to as the new oil, so it makes sense to refer to the vertically integrated data companies as the modern day Supermajors.
AWS, Azure, and GCP have all vertically integrated large swaths of the cloud computing industry, starting with the raw data storage and compute hardware in their massive data centers around the world.
Again, lots of things hyperscale, but very few thinks vertically integrate in such an extreme, super, and major way, as GCP, AWS, and Azure have.
Turning to GCP, the division recently reported a blockbuster quarter, growing 29% to $10.8B in Q2'24 sales, atop $~1.2B in operating income. Growth in operating income outpaced sales growth by a wide margin, demonstrating the inherent leverage within this line of business for Alphabet. This growth in operating income, reflective of an expansion in margins, conveys an important characteristic of these businesses, which lends to the notion that they should be referred to as Supermajors. We will discuss this idea further in just a moment.
GCP's Quarterly And Six Month Revenue & Operating Income
GCP's Sales Reach New Heights, Now At $44B In Annualized Sales
The primary reason I believe it's better to call these businesses Supermajors, as opposed to hyperscalers, is because the term Supermajors acknowledges their vertical integration, which will be and is currently very important for long term margin structures.
As just raw compute and storage businesses, net margins might not grow beyond 20-30% long term, but, as vertically integrated Supermajors, which can layer on asset light businesses that act as a "royalty on the growth of others," with examples of these businesses being app marketplaces or generative AI products or productivity applications that can be easily sold to existing customers, they could achieve possibly 35%+ free cash flow margins long term.
AWS has demonstrated its profitability potential recently by reporting its best cloud computing margins ever at 38% operating margins.
AWS Achieves 38% Operating Income Margins In Q1'24
Extrapolating those margins to GCP, presently, the division generates ~$17B in annualized operating income, which is growing at 29%. This could certainly be argued to be the profitability foundation of a business worth $600B+ in enterprise value.
Supermajor Application Marketplace Total GMV
In closing, Alphabet's GCP division, as one of the three cloud computing Supermajors, is certainly worth monitoring, and it also represents a division within a multi-product business, and we know well what the value of being a multi-product business is.
(If you'd like to learn more about this last statement, I invite you to read this Brief.)
Disclosures:
L.A. Stevens has not rated Alphabet.
