Investors in Alphabet Inc. are becoming more certain that the company's semiconductors could be a major source of future income for Google's parent company.
The stock's 31% fourth-quarter rally the tenth greatest performance in the S&P 500 Index is mostly due to the success of Alphabet's tensor processing unit, or TPU, chips.
The company's cloud computing business grew faster thanks to the TPUs, which were always viewed as a key internal asset. However, there is growing hope that Alphabet may begin selling the chips to outside parties, generating a new source of income that might eventually be valued at almost $1 trillion.
"TPUs are a good way for companies to diversify away from Nvidia, which means there's a lot of reason to be optimistic," stated Gil Luria, DA Davidson's head of technology research.
In the end, the semiconductor company might be worth more than Google Cloud. However, a better chip translates into a better, more effective cloud, even if it never sells a chip externally.
According to Luria, if Alphabet is serious about selling its TPUs, they may take 20% of the AI market in a few years, making it a $900 billion company.
Requests for comments were not answered by Alphabet. A representative for Nvidia cited CEO Jensen Huang's previous statement regarding the business's competitive edge, saying, "As a company, you're competing against teams."
Additionally, there aren't many teams in the world that are exceptionally skilled at creating these extraordinarily complex structures.
When Alphabet said in late October that it will provide Anthropic PBC with chips worth tens of billions of dollars, the stock saw a two-day increase of more than 6%.
Then, a month later, the Information revealed that Meta Platforms Inc. is negotiating to pay billions to gain access to TPUs, which led to yet another breakthrough.
TPUs are ASICs, or application-specific integrated circuits. They are, by definition, specially made for a certain purpose in this case, accelerating machine learning workloads.
They are therefore less versatile than Nvidia Corp.'s semiconductors, but they are also less expensive, which is a significant advantage at a time when investors are wary of spending on AI.
"If you can use an ASIC chip, Alphabet is right there and it leads that market by far, but Nvidia chips are much more expensive and difficult to obtain," stated Mark Iong, equity portfolio manager at Homestead Advisers. "This is part of the stock's secret sauce, but it won't control the entire market."
The introduction of Alphabet's most recent Gemini AI model, which got excellent reviews and is tailored to operate on the processors, confirmed the worth of the company's TPUs.
Long pointed to Gemini, Google Cloud, the TPUs, and a number of other areas, saying, "Alphabet is the only company with leadership in every layer of AI." "It has a huge advantage because of that."
Iong stated that although selling the chips to third parties might be in Alphabet's best interests, it is still unclear how committed the company is to doing so.
But according to Morgan Stanley analyst Brian Nowak, there are indications of a "budding TPU sales strategy" that may eventually increase sales.
According to Nowak, the Asia semiconductor analyst at Morgan Stanley predicts that five million TPUs will be purchased in 2027, up around 67% from earlier projections, and seven million in 2028, up 120%.
He noted in a note to clients on December 1 that this "speaks to the potential for GOOGL to sell more TPUs," even though the majority of this will probably come from Alphabet's first-party use and Google Cloud Platform sales.
According to Morgan Stanley's projections, every 500,000 TPU chips delivered to a third-party data center could increase Alphabet's revenue by roughly $13 billion in 2027 and its earnings per share by 40 cents.
According to expert estimates, Alphabet will generate around $447 billion in revenue in 2027, so an additional $13 billion would increase sales by over 3%.
Bloomberg data shows that over the last three months, consensus expectations for the company's 2027 revenue have increased by more than 6%.
Naturally, given the stock's skyrocketing value, strong expectations for Alphabet's semiconductor business could result in disappointment if the upside doesn't materialise.
The shares are trading at over 27 times projected earnings, which is much higher than their 10-year average and the highest since 2021.
However, Alphabet is still less expensive than Big Tech competitors like Apple Inc., Microsoft Inc., and Broadcom Inc. even at that level.
Recently, Allen Bond, portfolio manager at Jensen Investment Management, sold a portion of his holdings due to the stock's surge.
He is still optimistic about the company's overall situation and future, though, citing "a credible path to the TPUs becoming a driver of revenue."
"The valuation still looks reasonable given growth expectations, even though investors are increasingly appreciating Alphabet's tangible strength and progress with AI," he stated
"It continues to be a core holding because we have more evidence of AI momentum at a company that trades at a discount to Microsoft and Apple."
