Google's Hardware Ambitions Are Starting To Pay Off

Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) subsidiary Google has been taking hardware much more seriously over the past two years, starting with its first-generation Pixel smartphone. Since that device's launch, Google has aggressively expanded its first-party hardware offerings to include tablets, laptops, smart speakers, smart displays, and more, all under the leadership of hardware chief Rick Osterloh.

This article originally appeared in the Motley Fool.

Consumer hardware is a cutthroat business. Growing revenue is one thing, while becoming profitable is another altogether.

Google could generate $3 billion in hardware profits this year

RBC Capital Markets analyst Mark Mahaney released a research note last week providing some fresh estimates and insights regarding Google's hardware business. In Mahaney's view, Google's hardware segment has "gained critical success and are starting to gain material commercial traction." That notion reflects the fact that while Google's first-party devices have been garnering strong reviews among critics for quite some time, particularly in the camera department, unit volumes have historically not been all that great until recently. Google has to walk a fine line between competing with its hardware partners and also collaborating with them.

The search giant aggregates hardware revenue in its broader and vague "Other revenues" segment, which also includes businesses like Google Cloud and digital sales in the Google Play store. Other revenues jumped 30% in the third quarter to $4.6 billion and represented nearly 14% of Google's total revenue in the first three quarters of 2018. Google doesn't tell investors a lot when it comes to hardware, instead offering vague statements like "our hardware efforts are picking up real momentum."

Lacking official disclosures, that's where third-party analyst estimates come in. Mahaney is modeling for Google's hardware business to generate $8.8 billion in revenue this year, which should translate into gross profits of $3 billion. Hardware revenue is expected to soar to $19.6 billion in revenue by 2021, yielding $6.1 billion in gross profit that year, according to Mahaney's estimates. Google Home is expected to be the biggest contributor in 2021, representing $8.1 billion in revenue, followed by the Pixel lineup at $6.9 billion.

RBC believes that Google currently has an installed base of around 43 million Google Home devices in the U.S. in addition to another 9 million units installed internationally. The company has greatly expanded its Home lineup in recent years, most recently with the Google Home Hub.

Beyond financial results, Mahaney notes that the growing installed base of Google hardware gives it a powerful conduit to continue developing artificial intelligence (AI) and machine learning. Google could also serve up more ads through its hardware going forward.

It's no easy task competing with Apple (NASDAQ:AAPL) on the hardware front, but Google is giving the Mac maker a run for its money in several important product categories. Apple is especially weak in the smart speaker market, being not only late to the party but also pricing itself out of the mainstream with its $350 HomePod. It's not a coincidence that Apple's fumble is leaving an opening that Google is now expected to take advantage of in the years ahead.

Mahaney's price target on Alphabet shares is $1,400, roughly 40% above current levels.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.