Why Google Investors Might Finally Need to View the Company Differently

This article originally appeared on Real Money on Nov. 28, 2016.

Though Alphabet's  (GOOGL) Google has had substantial non-advertising revenue streams for some time, they've never been substantial enough for a company of its size to be viewed by Wall Street as something more than an online advertising play. While non-ad businesses might get some lip service in analyst reports, it has ultimately been ad sales -- and search ad sales especially -- that formed the heart of bull and bear cases about the company, and which determined how its shares moved after an earnings report.

That might finally be set to change a little, thanks to burgeoning hardware, cloud service and app store revenue streams. A pair of reports on Monday help drive this home.

In a report reiterating an Overweight rating and $950 target for Google parent Alphabet (GOOGL) , Morgan Stanley's Brian Nowak forecasts Google's just-launched Pixel phones -- the 5-inch Pixel and 5.5-inch Pixel XL -- will produce $2 billion in revenue this year via three million unit sales, and $3.8 billion in revenue next year via five to six million units.

Nowak also estimates the phones will have gross margins in the range of 22% to 25%. Given manufacturing costs aren't believed to account for more than 40% of revenue, the gross margin estimates feel low even after accounting for non-manufacturing costs such as royalties and warranty expenses.

Alphabet and Apple are holdings in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells AAPL? Learn more now.

Regardless, the estimates highlight how the Pixel phones, aided by good reviews, a large ad campaign and Samsung's  (SSNLF) Note 7 mess, are set to become a big business for Google, even if one assumes global Pixel sales will remain a fraction of the 230 million-plus iPhone sales claimed by Apple (AAPL) each year.

Nowak's report comes a week after Wave7 Research estimated the Pixel and Pixel XL accounted for 7.5% of Verizon's phone activations during the preceding month -- a solid number given the iPhone 7 launched in September.

Separately, The Information reported on Monday that Google's cloud revenue is set to more than double in 2016 to over $1 billion. It also reported Google is merging the sales teams for its public cloud services business (the Google Cloud Platform, or GCP) with those for its productivity apps (formerly Google Apps, now known as the G Suite) in an attempt to cut costs and more quickly close large deals.

Having $1 billion in annual sales would still make GCP a lot smaller than Amazon Web Services (AWS), which did $3.2 billion in revenue in the third quarter alone; Microsoft's (MSFT) Azure is also believed to be larger, though the software giant doesn't share a revenue figure for the business.

Still, GCP is showing impressive sales momentum since former VMware co-founder Diane Greene was put in charge of the business a year ago; Apple, Evernote and Spotify are among the cloud clients Google has either officially or reportedly won in recent quarters.

Then there's Google Play. Figuring out how much revenue the Play Store produces requires some guesswork and inference, since Google doesn't break out the number, but it appears to be well into ten figures. Apple reported over $20 billion in 2015 App Store gross revenue, which implies over $6 billion in net revenue after backing out the 70% cut given to developers (same as Google Play). Research firm App Annie, meanwhile, estimates App Store revenue was 75% higher than Google Play revenue last year.

If App Annie's estimate is right, it means Google Play's 2015 net revenue was above $3.4 billion, and its gross revenue above $11.3 billion. Chances are net revenue will be above $4 billion in 2016.

Altogether, revenue for the "Google Other" reporting segment, which covers all of Google's non-advertising businesses, rose 39% annually in Q3 to $2.4 billion. Though the figure doesn't include any Pixel phone revenue since the devices only launched in early October, that's equal to 11% of Alphabet's total sales. Another $197 million in revenue (along with $865 million in operating losses, to be fair) was provided by Alphabet's "Other Bets" segment, largely via the Nest/Dropcam smart home unit and Google Fiber.

Ads are still easily Google's biggest profit engine, but for the first time, they might not be the only important one. Alphabet's Q4 numbers, which will bake in the impact of a quarter's worth of Pixel sales, should drive this home.

More from Stocks

Dow Logs Eighth Straight Drop as Stocks Slump

Dow Logs Eighth Straight Drop as Stocks Slump

Novo Nordisk Stock Rises 4% Over 2 Sessions

Novo Nordisk Stock Rises 4% Over 2 Sessions

Stock Market Just Took Another Beating -- Here's What You Need to Know

Stock Market Just Took Another Beating -- Here's What You Need to Know

This Is What's Hot Thursday - Stocks Slide, Intel's CEO Woes & Major Movers

This Is What's Hot Thursday - Stocks Slide, Intel's CEO Woes & Major Movers

Daimler's Profit Warning Should Terrify Traders Before Earnings Season Begins

Daimler's Profit Warning Should Terrify Traders Before Earnings Season Begins