To The Moon

$Alphabet(GOOG)$ $Alphabet(GOOGL)$ and $Microsoft(MSFT)$ released their financial reports simultaneously, once again directly comparing their performance. Unlike in Q2, this time Microsoft saw a significant increase led by its cloud business, while Google experienced a 5% drop due to its cloud business falling short of expectations despite advertising exceeding expectations. However, we believe that the market's interpretation of Google is overly pessimistic. Summary 1. Expectations for Google's advertising business were already factored in before the Q3 financial report, making up for the overly pessimistic expectations in the first half of the year. Despite high US bond yields and persistent recession expectations, this did not affect advertisers' enthusiasm for advertising on Google. 2. Both search and YouTube experienced double-digit growth, solidifying Chrome's industry position and generating additional income from market overflow to TikTok and the streaming market. 3. The growth rate of Google's cloud business fell behind Microsoft Azure again in Q3, disappointing the market. Possible reasons for this include the high base effect from before, price increases following the release of Microsoft Copilot, and the synergy of AI business not catching up to Microsoft yet. 4. Compared to Microsoft, Google is more capable of monetizing AI products through advertising, and even profiting from competitors' products (such as ChatGPT with Chrome). The release of the Gemini large model may further enhance long-term monetization capabilities. 5. Profit margins remain unaffected, and free cash flow has increased by over 30%, indicating that competition in AI large models will not have a significant impact on the company. With current profit guidance, there is still room for valuation improvement. Overall, after-hours performance reflects the disappointment in Google's cloud business compared to Microsoft Azure, as well as the outflow of speculative funds that were bet on before the financial report. However, the price of around 130 has not broken the upward trend, and there is greater room for valuation after an increase in profits, providing a good opportunity for institutions to increase their positions. Q3 Earnings Review Revenue Revenue was 76.7 billion, a year-on-year increase of 11%, exceeding market expectations of 75.5 billion dollars and the highest since Q2 of last year; Google Services, including advertising, search, maps, YouTube, hardware, Android, Chrome, and Google Play, generated revenue of 59.65 billion dollars, with a year-on-year growth rate of 9.5%, higher than market expectations of 58.94 billion dollars; Revenue from search was 44 billion dollars, with a year-on-year growth of over 12%, and advertising revenue from streaming platform YouTube was 77.95 billion dollars, with a year-on-year growth of over 12%, higher than the expected 7.8 billion dollars. In comparison, the cloud business department had the highest growth rate, with revenue of 8.41 billion dollars, a year-on-year increase of 22%, slightly lower than the expected 8.64 billion dollars. Profit The company's overall operating profit was 21.34 billion dollars, with a year-on-year increase of over 24%, slightly lower than the expected 21.44 billion dollars, and an operating profit margin of 28%, also lower than the expected 28.1%. Capital expenditure was 8.06 billion dollars, lower than the expected 8.81 billion dollars. Among them, Google Cloud's operating profit was 266 million dollars, lower than the market expectation of 433.6 million dollars, and the operating profit margin decreased from 4.5% last year to 3.2%. Investment Highlights Firstly, the advertising business continues to grow steadily. Although it is still in a macroeconomic downturn, we believe that Google may outperform the industry average. There are two main reasons for this. First, similar to Q2, concerns about the economic downturn in the United States have not been reflected in the data. Despite the constant market noise about the "wolf is coming," advertising, as an economic barometer, has not shown significant decline. Second, compatibility with various browsers such as ChatGPT has continued to enhance Chrome's industry position, allowing Google to monetize its advertising business earlier. In addition, Google has YouTube to compensate for any loss in market share caused by information flow ads eroding search ads. The performance of deferred revenue (mainly YouTube and Play) also indicates a significant growth potential with a Q3 sequential growth of 15%. Second, the growth rate of cloud business is declining, but Google's ace in the hole is AI. Because in Q2, Google Cloud's growth rate surpassed Azure, investors habitually believed that Google Cloud's growth rate might continue to increase, but it unexpectedly fell after only one quarter, which disappointed the market. In fact, Google Cloud's base in the same period last year was higher, and many of its main customers were also in industries affected by "cost reduction and efficiency increase". However, since Microsoft released Copilot and raised the prices of Office components, its cloud business has also received some support, and Microsoft's enterprise customers tend to have greater stickiness due to bundled products. In terms of AI, Microsoft's OpenAI has taken the lead. However, as the hype around AI subsides in Q3, Google, Meta, and other vendors have the opportunity to catch up. We believe that AI is still the key to breaking the trend of Google Cloud's business. We found that Google started to increase its employees in Q3 on a month-on-month basis, and administrative expenses increased by 10%, which is obviously betting more on AI-related research and development. The company also stated on its conference call that AI and search assistants will be very important development opportunities in the next ten years, and it will increase investment in technology infrastructure in Q4. Google Brain's collaboration project with DeepMind, Gemini, is gradually progressing and laying the foundation for the next generation of models to be launched in 2024. Once Gemini's development meets customers' needs for various scales and functions, it will be immediately deployed to all internal products and provided to developers and cloud customers through Google's machine learning platform Vertex. This means that the most important node for the recovery of cloud business growth rate is the integration of AI products. How should we review "Microsoft up, Google down"? Microsoft's Q3 performance exceeded expectations at all levels. Although Bing search did not continue to expand its territory after a strong Q, it still brought more revenue, but the larger increment comes from products embedded with AI, such as Copilot's Office products and related cloud businesses. On the contrary, one of the major factors that the market bet on big tech this year is AI. Since Google did not meet "market expectations" in Q3, the market has "withdrawn some expectations" from its price and will wait until AI commercialization lands before making a decision. Therefore, the changes in stock prices after the financial report may only be short-term emotional expressions. Microsoft has priced in more AI commercialization, while Google has its chance with the Gemini large model. From a valuation perspective, as its main advertising business continues to strengthen, Google's PE in 2023 can drop to below 25 times, and EV/EBITDA can drop to 13 times under the new high cash flow situation, providing a valuation basis for further stock price increases.