Shareholders of Alphabet Inc. Are expressing heightened optimism that the firm's semiconductor offerings might emerge as a substantial contributor to the future earnings of Google's parent entity.
TL;DR
- Alphabet's TPUs are driving stock surges and cloud growth, with potential for external sales.
- TPUs offer a lower-cost alternative to Nvidia chips, appealing to AI diversification needs.
- Analysts foresee significant revenue and earnings growth from potential TPU sales to external clients.
- Despite high valuation, Alphabet's AI strength and TPU potential offer a compelling investment case.
Alphabet's tensor processing unit, or TPU, chips have been a key factor in the stock's 30% surge during the fourth quarter, positioning it as one of the top performers within the S&P 500 Index. These TPUs were consistently recognized as a significant internal advantage, boosting the expansion of the company's cloud-computing operations. However, there's growing confidence that Alphabet might begin offering these chips to external clients, establishing an additional source of income in a sector that could eventually reach a valuation close to one trillion dollars.
Shares were down 1% on Thursday.
“If companies want to diversify away from Nvidia, TPUs are a good way to do it, and that means there’s a lot of reason to be optimistic,” said Gil Luria, head of technology research at DA Davidson. “The chip business could ultimately be worth more than Google Cloud. But even if it never sells a chip externally, the better chip means a better, more efficient cloud.”
Luria suggests that if Alphabet were to actively pursue the sale of its TPUs, they might secure a 20% share of the artificial intelligence sector within a few years, transforming it into a business valued at approximately $900 billion.
Alphabet did not respond to inquiries for a statement. A representative from Nvidia referenced a recent remark by Its Chief Executive Officer, Jensen Huang, concerning the firm's competitive edge: “As a company, you’re competing against teams. And there just aren’t that many teams in the world who are extraordinary at building these incredibly complicated things.”
Towards the end of October, Alphabet announced announced its intention to provide Anthropic PBC with tens of billions of dollars worth of chips, which propelled the stock to a two-day surge exceeding 6%. Subsequently, a month later, The Information disclosed that Meta Platforms Inc. Is negotiating to invest billions for access to TPUs, igniting another significant increase.
TPUs are custom-built chips, also known as application-specific integrated circuits (ASICs). Their design is specifically tailored for a singular purpose, which in this instance is to speed up machine learning tasks. This specialized nature renders them less adaptable compared to the semiconductors produced by Nvidia Corp., but it also results in a lower cost, a significant advantage during a period when stakeholders are scrutinizing expenditures on AI.
“Nvidia chips are much more costly and hard to get, but if you can use an ASIC chip, Alphabet is right there, and it leads that market by far,” said Mark Iong, equity portfolio manager at Homestead Advisers. “It won’t control the entire market, but this is part of the secret sauce for the stock.”
The significance of Alphabet’s TPUs was confirmed by the introduction of the firm's newest Gemini AI model, which garnered glowing reviews and is engineered to operate on these specialized processors.
“Alphabet is the only company with leadership in every layer of AI,” Iong said, pointing to Gemini, Google Cloud, the TPUs and several other areas. “That gives it an incredible advantage.”
Iong stated that while it might benefit Alphabet to offer the chips to external companies, their dedication to this strategy is uncertain. Nevertheless, Morgan Stanley analyst Brian Nowak observes indicators of a “budding TPU sales strategy” that might eventually boost earnings.
Nowak cited Morgan Stanley’s Asia semiconductor analyst, who expects about five million TPUs to be bought in 2027, up roughly 67% from previous estimates, and seven million in 2028, 120% above prior estimates. While most of this will likely come from Alphabet’s first-party use and Google Cloud Platform sales, it “speaks to the potential for GOOGL to sell more TPUs,” he wrote in a note to clients on Dec. 1.
Alphabet's 2027 revenue could see an increase of approximately $13 billion for every 500,000 TPU chips supplied to an external data center, alongside a 40-cent rise in earnings per share, as per Morgan Stanley's projections. Analysts anticipate Alphabet will generate around $447 billion in revenue by 2027, meaning an additional $13 billion would represent a nearly 3% increase in sales. Data gathered by Bloomberg indicates that the collective forecasts for the company's 2027 revenue have climbed by over 6% in the last quarter.
Naturally, significant expectations for Alphabet's semiconductor division might result in letdown should the positive outcomes not come to fruition, especially given the stock's escalating worth. The equity is currently valued at approximately 27 times projected profits, close to its peak since 2021 and considerably higher than its decade-long average. Nevertheless, even at this valuation, Alphabet remains more affordable compared to major technology competitors such as Apple Inc., Microsoft Inc., and Broadcom Inc.
Allen Bond, a portfolio manager with Jensen Investment Management, recently took advantage of the stock's surge to divest a portion of his holdings. Nevertheless, he maintains an optimistic outlook regarding the firm's broader standing and future potential, encompassing “a credible path to the TPUs becoming a driver of revenue.”
“Alphabet is showing tangible strength and progress with AI, and while that’s increasingly appreciated by investors, the valuation still looks reasonable given growth expectations,” he said. “The fact that we have increased evidence of AI momentum at a company that trades at a discount to Microsoft and Apple means it remains a core holding.”
