A major Wall Street bank is betting that a shift in revenue mix could unlock higher valuations for Alphabet (GOOGL).
In a new CNBC interview, Wells Fargo Securities senior internet analyst Ken Gawrelski believes that Google may be entering a new phase driven by artificial intelligence monetization.
Gawrelski thinks Google’s AI spend is peaking just as its free cash flow recovers with the help of AI-driven revenue streams.
“You’ve seen meaningful upward revisions in CapEx the last four or five quarters, with a lack of upward revenue revision. And so that means free cash flow has been cut pretty meaningfully. What we think is going to happen here is that we think free cash flow will stabilize and start to rise as CapEx stabilizes here for a while.
And you’ll start to see these new revenue streams. And that’s what we really pointed out today, which was the ability to license their TPUs. This is the first true organic AI revenue that Google can recognize that is truly incremental. And we’re looking at this as a very high margin revenue stream.”
Tensor Processing Units (TPUs) are custom chips designed by Google, built specifically to train and run AI models. Gawrelski appears to be saying that other companies rent or use Google’s AI chips for a fee so they can train and run AI models without owning hardware.
The Wells Fargo analyst takes his thesis a step further and says that, along with TPU licensing, Gemini subscriptions will enable Google to become a more valuable company in the coming years.
“This was a consumer advertising story. And we think the next leg of this is far more subscription and enterprise-based. And to the point I made earlier, the worries on cyclical, we think the key drivers here are not the cyclical drivers of the past, the advertising side. Yes, advertising should continue to be quite robust here. But going forward, we think the key upside drivers are really on non-cyclical factors. And this has to do with when you think about the TPUs, you think about the subscriptions that they’re going to drive off of their model build in the Gemini model. This is where we think the real upside is.
And I think this actually represents a pretty big shift in the business mix here. And ultimately, in the end, I think this ends up being a higher multiple company than it was over the last five years.”
Gawrelski says Wells Fargo is overweight on GOOGL with a price target of $397, suggesting a 45% upside from its current price of $274.
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