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Alphabet Bets Big on Cloud, Shifts Away from Moonshots

Oct. 28, 2016
Google CEO Sundar Pichai said the cloud business is building a team focused on machine learning, an important branch of AI, and is hiring aggressively: “As we head into 2017, I expect cloud to be one of our largest areas of investment and growth.”

Alphabet Inc. will focus its biggest bets next year on the staid world of business software and cloud computing, a marked departure from lofty “moonshots” of recent years, such as burrito-carrying drones and super-fast internet service.

Alphabet was formed last year, in part, to insulate the lucrative online advertising business of its Google division from riskier, more capital-intensive projects now called Other Bets.

The strategy was on display in the company’s third-quarter results, released on Thursday. The technology giant culled investment in Other Bets and doubled down on Google’s cloud and artificial-intelligence initiatives. Those investments will only accelerate next year, executives told analysts during a conference call that followed a strong third-quarter report, driven largely by growth in Google’s main digital ad business. The shares rose 1.4% to $829 in premarket trading Friday.

Google CEO Sundar Pichai said the cloud business is building a team focused on machine learning, an important branch of AI, and is hiring aggressively: “As we head into 2017, I expect cloud to be one of our largest areas of investment and growth.”

Google is racing against Amazon.com Inc., Microsoft Corp. and other big technology companies to provide AI-powered services over the internet from remote data centers. The combination of these technologies may produce powerful and lucrative new products for consumers and business customers.

Google doesn’t disclose the performance of its cloud business. But its “other revenue” line, which includes this unit along with the Google app store and hardware sales, saw revenue grow 39% to $2.4 billion in the third quarter.

Chief Financial Officer Ruth Porat said the cloud division is “generating substantial revenue growth.” Cloud chief Diane Greene has helped win new corporate customers for its data-processing, analysis and storage services this year.

Google is still behind market leader Amazon.com Inc. which posted a 55% gain in cloud revenue on Thursday, reaching $3.2 billion for the third quarter. However, Google executives’ rhetoric suggests Alphabet is plowing money into businesses capable of generating strong returns, and cutting investment from projects with more questionable financial potential. Porat also cautioned investors that marketing spending will rise in the fourth quarter to promote new Google hardware like its Pixel smartphones.

Pichai and Porat have told investors before that Alphabet’s biggest bets are inside Google. Pichai oversees most of the company’s AI and virtual reality efforts, along with its costly data centers.

Yet shout-outs for the cloud business came amid a pullback from Alphabet’s Other Bets, particularly its Google Fiber internet service and Nest connected-device subsidiary.

The Other Bets segment, which also includes the autonomous vehicle project and two biotech research initiatives, lost $865 million in the third quarter, narrowing from a $980 million loss a year ago. Growth in capital expenditures on these businesses also slowed down from the prior two quarters.

Porat stressed that Other Best are on a “longer time horizon,” but also said Alphabet is resetting some of them as they strive to find business models. Earlier in the week, the Fiber internet service announced a retreat from eight major proposed markets as well as jobs cuts and the loss of its top executive. That followed a string of high-level departures from Other Bets companies.

“News that Fiber has been ‘paused’ should be welcomed by investors concerned over rising CapEx,” Daniel Salmon, an analyst at BMO Capital Markets, wrote in a note to investors.

Porat said Fiber had made “important breakthroughs” in wireless technology, but is re-evaluating expansion plans. “We wanted to focus on the potential with these efforts before we re-accelerate deployment,” she said.

Pichai shrugged off the executive exits. He also dismissed concern about other notable departures from Alphabet, including a team of veteran engineers from its self-driving car project, who were recently acquired by Uber, and Niantic Labs, the company behind the viral mobile game Pokemon Go.

“We generally want to create a culture of innovation, and that’s what we focus on and it is fine that some of them happen outside,” he said. The CEO also noted “world-class products” from Alphabet that serve over one billion users. All of them come from Google.

By Mark Bergen

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Licensed content from Bloomberg, copyright 2016.

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