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Are Wall Street’s Estimates for Alphabet’s Fourth Quarter Too High?

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Mizuho analyst James Lee questions the accuracy of Wall Street’s estimates for Alphabet’s fourth quarter. In a recent research note, Lee expresses concerns about the near-term outlook for the company’s cloud business and the expenses associated with its NFL Sunday Ticket football streaming package on YouTube.

Concerns about the Cloud Business

While maintaining a Buy rating and a target price of $155 for Alphabet shares, Lee acknowledges the long-term potential of the Google parent. However, he raises some clear worries regarding the fourth quarter.

Lee points out that the recent “optimization” pressures affecting major cloud computing providers, namely Google Cloud, Amazon Web Services (AWS), and Microsoft Azure, will continue to impact Google Cloud for another one or two quarters. AWS experienced six quarters of growth deceleration in the past, and Google Cloud has already faced four quarters of slowed growth. For the fourth quarter, Lee predicts a revenue growth rate of 21% for Google Cloud, which falls three percentage points below the consensus estimate. This follows disappointing results in the September quarter, where Google Cloud’s growth slowed from 28% in the June quarter to 22%.

Looking ahead to 2024, Lee forecasts a 20% cloud revenue growth rate at Alphabet, which is two percentage points below the consensus view.

Expenses

In addition to concerns about the cloud business, Lee believes Wall Street is overly optimistic about operating expense growth and overlooking two areas of increasing costs. However, he does not provide specific details about these expense areas.

Alphabet shares have seen a decline of 2.4% on Monday, currently trading at $128.74.

Legal Costs and Operating Loss for Alphabet

Alphabet Inc., the parent company of Google, is expected to face significant legal costs in the coming months. In the third quarter alone, the company had recognized a staggering $600 million in legal expenses. However, analysts predict that this figure will be even higher in the fourth quarter.

Another area of concern for Alphabet is their NFL Sunday Ticket package. Andries Lee, an industry expert, reveals that the company is likely to experience a substantial operating loss related to this package during the current quarter. The costs for Sunday Ticket are recognized incrementally throughout the season as games are played. Lee estimates that approximately 50% of the $1.8 billion annual licensing cost for Sunday football games will be acknowledged in the fourth quarter, amounting to a colossal expense of $900 million.

Aside from these challenges, Lee also highlights that investors need to be more cautious about Alphabet’s investment in infrastructure to support their cloud and AI businesses. He suggests that the current consensus regarding their operating margin of 27.5% might be overly optimistic, predicting a more conservative estimate of around 26.5%.

In conclusion, Alphabet Inc. is bracing itself for substantial legal costs and an operating loss in relation to their NFL Sunday Ticket package. Moreover, prudent consideration of their investment in infrastructure is crucial as they navigate the expanding world of cloud and AI technologies.

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