Google: Two Huge First Quarter Items You Might Have Missed (Hint: It’s Not Artificial Intelligence) (NASDAQ:GOOG)

The markets breathed a sigh of relief recently as the profits of big tech companies came out better than feared.

the alphabet (Nasdaq: Google) (Nasdaq: GOOGLE), Microsoft (MSFT), Apple (AAPL), and even Amazon (AMZN) avoided major sell-offs, as seen below.

talking about Since the advent of OpenAI’s generative chatbot, ChatGPT has become Artificial Intelligence (AI) and Machine Learning (ML).

In fact, artificial intelligence has been mentioned 49 times (Really!) on Alphabet’s earnings call and was the subject of the first two analyst questions.

So why now? After all, these companies have been integrating, using, and spending billions developing AI and machine learning tools for years. ChatGPT’s debut brought the technology into the spotlight, and Microsoft’s billion-dollar investment was a gunshot in the battle to make Bing a legitimate competitor to Google Search.

Many believe that artificial intelligence will be as transformative for society as the internet. no A tech company can appear unprepared or left behind. Alphabet quickly introduced its chatbot, Bard, detailed its other efforts and merged its existing AI research teams to form DeepMind.

This technology race will be crucial to Alphabet’s future, but the immediate hype will inevitably fade as the mainstream media progresses. Transformational changes take time.

Meanwhile, there was important news from Google Q1 which is vital for investors now.

Let’s take a look at two items that seem to be flying under the radar.

#1: Focus on efficiency

Alphabet CEO Sundar Pichai pledged to make the company 20% more efficient when he spoke in 2022.

Revenue skyrocketed as economic stimulus poured in during the pandemic, and Alphabet has increased spending. As shown below, total operating costs and expenses increased by 63% between 2019 and 2022.

The number of employees has nearly doubled to more than 190,000 employees through the end of 2022, as shown below.

Number of employees is not the only contributor to increased costs, but it is a huge factor. The growth seen immediately after the pandemic is not sustainable, nor is the aggressive spending.

Management should address efficiency for two reasons:

1. Financial performance
2. Organizational flexibility.

Financial efficiency

Alphabet’s operating margin rose to more than 30% in 2021 as sales rose 41%. However, growth is back on the ground, the economy is challenging, and operating margins are declining, as shown below.

Google reported $2.6 billion in fees related to cost-cutting initiatives in the first quarter, with $2 billion in severance costs and $560 million in reduced office space.

Removing this one-time fee raises operating margin again above 28%. This is a small sign that the simplification plan could be working.

Organizational flexibility

Google seemed to be caught when ChatGPT took over the country. They quickly highlighted their initiatives, but the perception is that they are too late.

More is not always better for businesses. Having too many chefs in the kitchen slows decision making and leads to poor overall execution.

Airbnb (ABNB) is a great example of how a company can succeed by focusing on bottom line results and efficiency.

The pandemic has wiped out Airbnb’s top line and forced the company to streamline. Airbnb revenue is now up 75% since 2019, yet headcount is still down 5% minimum As of the fourth quarter of 2022. As a result, Airbnb had its first profitable GAAP year in 2022 with a great operating margin and great free cash flow. That’s very impressive for a young growth company.

Airbnb CEO Brian Chesky said on the fourth quarter earnings call:

… At the expense of personnel, something really interesting happened. So obviously, in 2020, we’ve had to make some really tough decisions, and we’ve become a much smaller, more focused company. The obvious result is that we are becoming more efficient and profitable. But there was a less obvious result. What eventually happened was we had fewer people in meetings, and people could move more quickly. And we concentrate all our best people and only get them into some trouble.

Google cannot afford to be caught again because it competes with Microsoft in search and artificial intelligence; Being flexible and responsive is crucial.

#2: Is Google Cloud profitable?

Well, it’s complicated. But let’s not miss the forest debate about trees.

Investors and commentators have followed Google Cloud’s monetization path closely. For some history, please take a look at this article I recently published.

Great news! The Google Cloud segment posted an operating profit for the first time in the first quarter, as shown below.

But it’s not that simple (is it ever?).

Alphabet changed accounting estimates for server and network equipment depreciation, extending useful life from four to six years. This reduced operating expenses by $988 million in the quarter. It’s likely a big chunk that hit the Google Cloud segment and drive it to operating profitability.

Many have argued whether this is progress or just a gimmick to make the results appear better. But this is not important.

The catch is that depreciation is a non-cash expense, and the change resulted in positive operating income. This shows that the Google Cloud segment has a significant backlog in EBITDA and operating cash flow. This is the important positive news.

Can Google shares be bought?

Alphabet reported strong first quarter results, with revenue growth of 3% led by 28% growth in Google Cloud. Operating income and earnings per share were down, but that was to be expected, given the inflation and one-off fees discussed above.

The company is a cash flow machine with $23.5 billion in operating cash flow for the quarter. Share buybacks increased to $14.6 billion in the first quarter, and another $70 billion (about 5% of market cap) was approved recently.

Despite the manual maneuvering on Microsoft and ChatGPT, it’s not likely that Google Search will be phased out anytime soon. Alphabet has its own AI initiatives and an impressive research team at DeepMind. There’s still a long runway ahead for the cloud, and YouTube is getting a much-needed boost with new leadership.

The valuation remains below historical averages, as seen below.

Alphabets’ focus on efficiency, impressive cash generation, and a renewed urgency to innovate makes it a solid long-term investment.