Alphabet’s TPU AI chips are a potential US$900 billion ‘secret sauce’

[NEW YORK] Alphabet investors are growing increasingly confident that the company’s semiconductors could represent a significant driver of future revenue for Google’s parent.

The success of Alphabet’s tensor processing unit, or TPU, chips is a primary reason for the stock’s 31 per cent fourth-quarter rally, which is the tenth best performance in the S&P 500 Index.

The TPUs were always seen as a major strength internally, accelerating growth for the company’s cloud-computing business. But there is rising optimism that Alphabet could start selling the chips to third parties, creating a new revenue stream that could ultimately be worth almost a trillion US dollars.

“If companies want to diversify away from Nvidia, TPUs are a good way to do it, and that means there’s a lot of reason to be optimistic,” said Gil Luria, head of technology research at DA Davidson. “The chip business could ultimately be worth more than Google Cloud. But even if it never sells a chip externally, the better chip means a better, more efficient cloud.”

Should Alphabet get serious about selling its TPUs, Luria estimates they could capture 20 per cent of the artificial intelligence market over a few years, which would make it a roughly US$900 billion business.

Alphabet did not return requests for a comment. A Nvidia spokesperson pointed to a recent comment by CEO Jensen Huang about the company’s competitive advantage: “As a company, you’re competing against teams. And there just aren’t that many teams in the world who are extraordinary at building these incredibly complicated things.”

In late October, Alphabet announced that it will supply tens of billions of US dollars of chips to Anthropic PBC, which sent the stock on two-day rally of more than 6 per cent. Then a month later, the Information reported that Meta Platforms is in talks to spend billions for access to TPUs, sparking another leap.

TPUs are application-specific integrated circuit, or ASIC, chips. By definition, they’re custom designed for a particular use, in this case to accelerate machine learning workloads. That makes them less flexible than the semiconductors made by Nvidia, but it also makes them cheaper, which is a real benefit at a time when investors are questioning AI-related spending.

“Nvidia chips are much more costly and hard to get, but if you can use an ASIC chip, Alphabet is right there, and it leads that market by far,” said Mark Iong, equity portfolio manager at Homestead Advisers. “It won’t control the entire market, but this is part of the secret sauce for the stock.”

The value of Alphabet’s TPUs was corroborated by the launch of the company’s latest Gemini AI model, which received glowing reviews and is optimised to run on the chips.

“Alphabet is the only company with leadership in every layer of AI,” Iong said, pointing to Gemini, Google Cloud, the TPUs and several other areas. “That gives it an incredible advantage.”

While it may be in Alphabet’s best interest to sell the chips to third parties, it remains unclear how focused it is in doing so, Iong said. However, Morgan Stanley analyst Brian Nowak sees signs of a “budding TPU sales strategy” that could ultimately drive revenue.

Nowak cited Morgan Stanley’s Asia semiconductor analyst, who expects about five million TPUs to be bought in 2027, up roughly 67 per cent from previous estimates, and seven million in 2028, 120 per cent above prior estimates. While most of this will likely come from Alphabet’s first-party use and Google Cloud Platform sales, it “speaks to the potential for GOOGL to sell more TPUs,” he wrote in a note to clients on Dec 1.

Every 500,000 TPU chips sold to a third party data centre could add about US$13 billion to Alphabet’s 2027 revenue, and 40 cents to its earnings per share, according to Morgan Stanley’s estimates.

Alphabet is expected to post roughly US$447 billion in revenue in 2027, based on analyst projections, so adding US$13 billion would boost sales by almost 3 per cent. Consensus estimates for the company’s 2027 revenue have risen by more than 6 per cent over the past three months, according to data compiled by Bloomberg.

Of course, high hopes for Alphabet’s chips business could lead to disappointment if the upside fails to materialise, particularly with the stock’s soaring valuation. The shares are trading at around 27 times estimated earnings, the highest since 2021 and well above their 10-year average. But even at that level, Alphabet is still cheaper than Big Tech rivals like Apple, Microsoft and Broadcom.

Allen Bond, portfolio manager at Jensen Investment Management, recently used the stock’s rally to sell some of his stake. However, he remains positive on the company’s overall position and prospects, including “a credible path to the TPUs becoming a driver of revenue.”

“Alphabet is showing tangible strength and progress with AI, and while that’s increasingly appreciated by investors, the valuation still looks reasonable given growth expectations,” he said.

“The fact that we have increased evidence of AI momentum at a company that trades at a discount to Microsoft and Apple means it remains a core holding.” BLOOMBERG