• 3Q23 results were within expectations. 9M23 revenue/PATMI were at 72%/71% of our FY23e forecasts. PATMI grew 42% YoY on higher operating leverage.
• Ad revenue rebounded for a 3^rd straight quarter as retail advertisers began preparing for the holiday season. Ad revenue growth tripled sequentially to 9% YoY.
• Cloud was a disappointment, with revenue growth decelerating to 22% YoY due to moderating client spend, losing ground on competitor Microsoft’s Azure (29% YoY).
• We maintain BUY with an unchanged DCF target price of US$144, with a WACC of 7.3% and a terminal growth rate of 3.5%.

The Positives

+ Rebound in Search and YouTube ad revenue driven by Retail. Advertising continued to rebound for a 3^rd straight quarter, with a 9% YoY increase in 3Q23 ad revenue. Search and YouTube advertising saw growth of 11% and 12% YoY, respectively, driven by its Retail vertical as AI-powered solutions like Performance Max continued to deliver more reliable and better ROI to advertisers preparing for a long holiday season. Overall Ad revenue growth tripled sequentially to 9% YoY vs 3% in 2Q23 (Figure 2), which is encouraging after lacklustre growth over the last 12-15 months. We anticipate a further recovery in ad revenue this holiday season as US consumer sentiment remains resilient, and forecast a 13% YoY growth for total revenue in 4Q23e.

+ Net margins expanded on higher operating leverage. GOOGL expanded its net margins by 110bps/550bps QoQ/YoY to 25.7%, with PATMI also growing by 42% YoY – its largest growth in 18 months. The main reason for the margin expansion is due to GOOGL beginning to see the full effects of its cost optimisation initiatives – smaller office footprint and less fixed costs, with 3Q23 earnings also lapping prior periods which incurred optimisation-related charges. We believe that GOOGL’s continued focus on efficiency should help to drive margins further as topline growth accelerates again.

The Negative

– Cloud growth continued to moderate, losing ground on Azure. GOOGL’s Cloud business saw revenue growth continue to decelerate to 22% YoY, down from 28% in 2Q23. The weakness was mainly due to continued optimisation in spend for some of its clients, which was slightly disappointing given competitors like Microsoft’s Azure saw a rebound to 29% YoY growth vs 26% YoY in the prior quarter. Cloud’s operating margin was also a slight disappointment, declining sequentially to 3%, from 5% in 2Q23, as GOOGL ramped up its infrastructure investments to support future AI-related Cloud growth. We expect Cloud margins to remain muted in the near-term given the expected elevated levels of CAPEX in data centres and servers.