Rationale For Google’s Spending On Data Centers

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Google (NASDAQ:GOOG) is a household name due to the popularity of its search engine. However, the company realizes that the robust growth it witnessed in online ads market in the last decade might not be sustainable in the future, partly due to the limits to the total addressable market (TAM) in the existing market and the rising competition from in mobile app data. As a result, the company is looking to expand its footprint by launching cheaper devices in new markets and propagating new business streams such as cloud services etc. However, in order to achieve this objective, the company continues to build out its data centers, which not only support and complement its core search business but would also help it to expand its services in the cloud vertical. In this note, we will explore Google’s push for data centers.

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Expanding Internet Userbase

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In the last five years, Internet penetration has increased from 1.8 billion or 26.6% of the world population to 2.8 billion or 39%. [1] Furthermore, companies around the world continue to lure more people to the Internet by introducing cheap smart connected devices. Considering the penetration in mature market, hardware manufacturers are now focusing on emerging countries, which include over 85% of the world population, and contribute almost three quarters of global GDP growth, according to Fidelity Investment Ltd. [2] While majority of the population in these countries is below poverty line, the elite and aspiring middle class make up nearly 20% of the population. However, as economic development gains traction in these countries, many households are expected to move to higher income bracket in the future. For example, India’s middle class has 250 million people, which is expected to grow to 600 million by 2030, according to Deutsche Bank research. [3] We believe that as purchasing power in developing countries improves, discretionary spending will rise as disposable income grows, which will fuel demand for luxury items such as smartphones, net books and tablets that can connect on the internet.

Google, like many other companies such as Microsoft etc, has done its bit by launching cheap Android based platform under the Android One name. [4] Furthermore, PC manufacturing companies like HP are also introducing cheap Windows-based thin tablets and laptops. [5] In addition to the traditional devices that log onto Internet, entertainment devices such as Televisions and game consoles can now connect to the Internet to access and download content. All these new devices are adding new users to the Internet community. However, as the user base for smart connected devices grows, so will the need to store data and maintain the quality of service on the Internet. To ensure that it remains unchallenged in its dominance in search (close to 65% in desktop and 90% in mobile), Google must strive to maintain the quality of service.

Expansion of Cloud Services

Over the past few years, cloud services have come to fore for both large and SME (small and medium size enterprise) companies that looking to improve their businesses by employing IT solutions and services. The advantage of cloud services is the scalability and accessibility to new applications, resources and services. Furthermore, cost associated with using these services are less as the onus of management of these services lie with the cloud services provider. As a result, the demand i s growing for virtualization services, which enable service provider to creating a virtual computer domains independent of the underlying software and  hardware, increasing manageability and reducing cost. This has translated into a CAGR of 17.6% from 2014 to 2020 for the global cloud services market, and expected to reach a market size of $555 billion in 2020 from $209.9 billion in 2014, according to the new report by Allied Market Research. [6]

Google’s Spending On Data Centers

Google has been steadily ramping up its spending in each of the last ten quarters, crossing the $2.2 billion per quarter mark late last year. This unprecedented level of spending reflects the breadth of Google’s server farm construction program. In the past, Google has undertaken both green field projects (setting up new data centers) and brown field expansion (supplementing capacity at existing centers). In the past nine months, this trend seems to continue. In September, Google announced a new EUR600 million investment over the next four years to build a new data centre in Eemshaven, the Netherlands. [7] The company plans to invest in new facilities in Ireland, Finland, and Belgium in the coming years. Furthermore, it is planning to invest $100 million to $200 million in expanding its Taiwan data center, which was had an investment outlay of over $600 million in earlier phases. In all, the company has spent over $7.5 billion on datacenters in the first nine months of 2014, and the capex is expected to increase to over $10 billion by the year end. While many investors believe that Google may be building data centers even before the company needs them, we believe that it is worth having excess capacity on standby than not having it to support the quality of service and new products.

We currently have a $547 price estimate for Google, which is inline with its current market price.

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Notes:
  1. Internet Growth Statistics []
  2. Emerging markets insight []
  3. The middle class in India, www.dbresearch.de []
  4. Read more about this here []
  5. Read more about this here []
  6. Global Cloud Services Market is Expected to Reach $555 Billion by 2020, July 2 2014, www.bizcloudnetwork.com []
  7. Expanding our data centres in Europe, September 23 2014 []