Why Google is Spending Big on Undersea Cables

To some, it may seem that Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) has some catching up to do in the cloud computing wars. A distant third-place contender behind dominant Amazon (NASDAQ: AMZN) and No. 2 Microsoft (NASDAQ: MSFT), Google was estimated to have made only $900 million in cloud revenue in 2016, far behind the $12.2 billion Amazon made and the $2.4 billion Microsoft made cloud computing services that year.

Recently, however, Google has been making a bigger push into the cloud, touting its artificial intelligence chops and high-speed network in competition with the big two. The company recently won a contract with PayPal, which chose Google's cloud for its consistently high speeds over its privately owned fiber network. Google already has the world's largest privately owned fiber optic network, which currently handles a massive 25% of the world's internet traffic for its search and YouTube offerings, according to the VP of engineering for Google's cloud business, Ben Treynor.

To bolster its newer cloud product and expand its reach into new geographies, however, Google also must greatly expand its network for the public cloud -- and it recently announced it will be spending big on that initiative.

Under the sea

Last week, Google announced it was building three undersea fiber optic cables, which will cost hundreds of millions of dollars, in the Atlantic and Pacific oceans. One cable will connect Los Angeles to Chile, where Google recently built a large data center. A second cable, built in partnership with Facebook (NASDAQ: FB), will connect the East Coast of the U.S. with Denmark. A third cable will connect Hong Kong and Guam, which will link Google's network to Australia and East Asia. With the three new cables, Google will own part or all of 11 such undersea connections.

The new cables will connect customers with five new "cloud regions" across the world. For reference, a cloud region is a larger geography that can be divided into zones, where a company can store applications and data in a cloud provider's data center.

Spreading the cloud

Besides the new infrastructure investments, Google is also making serious personnel investments in the cloud. During its third-quarter earnings call, Google said most of the 2,500-person increase in headcount was for cloud engineers and sales. While Google doesn't break out its cloud revenue specifically, its "Google other" segment grew a solid 40% year over year in Q3, and cloud growth was likely much larger than that.

In fact, Google posted the highest cloud growth of all vendors in the third quarter except for Microsoft, according to research group Canalys. While there's still quite a bit of distance between Google and its rivals, that gap could very well close in the years ahead. The three new undersea cables won't be completed until 2019, so Google is investing years ahead of projected revenue.

The opportunity

There is a lot at stake in the cloud industry. With the huge costs associated with building data centers all over the world, private fiber optic infrastructure, and various platform and software tools, there are really only a few companies with the cash resources to compete in cloud infrastructure, and Google is one of them. In order to catch up to rivals, it must spend as well; Amazon is known for spending aggressively, and Microsoft just completed an ultra-fast undersea cable with Facebook back in September.

And while there are only a few players competing, the revenue opportunity is large -- very large. In fact, by 2020, research firm Gartner (NYSE: IT) believes $1 trillion in IT spend could move to the cloud. Given the billions of dollars at stake, Google is absolutely taking the right approach by spending heavily now. Investors should keep an eye on this space, as the growth runway is long, the IT market is huge, and with only a few heavyweights in contention, the stakes are as well.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Billy Duberstein owns shares of Alphabet (C shares), Amazon, Facebook, and Microsoft. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, and PayPal Holdings. The Motley Fool has the following options: long March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.