Could This Surprise Company Become Nvidia's Biggest Competitor?

Key Points

• Nvidia is currently the clear leader in AI infrastructure.

• However, Alphabet may be a surprise contender to become its biggest competitor.

• The company started renting out its TPU chips earlier this year, and OpenAI has begun testing them.

Nvidia (NASDAQ: NVDA) has long been the dominant player in the artificial intelligence (AI) infrastructure market. Its graphics processing units (GPUs) are the main chips used to power AI workloads, while its CUDA software platform has helped create a wide moat. However, if there is a surprise company that can challenge Nvidia, it's Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG).

Today, most companies running AI workloads use Nvidia's chips. However, Alphabet has turned to its own in-house chips called Tensor Processing Units (TPUs) to help reduce costs and improve performance.

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Alphabet's TPU opportunity

Alphabet uses TPUs internally for AI workloads, but it also rents the chips to outside developers. It was initially reported that OpenAI was renting Alphabet's TPUs to help run ChatGPT, although the company has since said it is just testing the chips and not looking to deploy them at scale at this time. Nonetheless, this is a big development. OpenAI is one of Nvidia's largest customers and a Google rival, and the fact that it is looking at Alphabet's TPUs demonstrate the capabilities and cost advantages its chips can provide.

What makes TPUs so compelling is that they are specifically designed for Google's infrastructure, giving them advantages in latency, scalability, and cost. As the market starts to shift toward AI inference, Alphabet's TPUs could become a better choice than GPUs. Meanwhile, Alphabet recently introduced a TPU specifically designed for inference called Ironwood in April.

Alphabet's vertical integration also gives it a potential edge. It's one of the few companies that can offer custom AI chips, a top-tier cloud-computing platform, and a full software platform. Nvidia may dominate GPUs, but it doesn't offer a cloud-computing platform. This is something that Alphabet can take advantage of, especially with inference where pricing and latency are more important considerations.

The market backdrop is also favorable for Alphabet. Spending on AI infrastructure is expected to remain strong, with Nvidia projecting global data center capital expenditures (capex) to surpass $1 trillion by 2028. At the same time, many experts are predicting that inference will become a much larger market than model training. AI inference is much less technically challenging than AI training, which helps negate some of Nvidia's CUDA advantage. This could lead to more companies looking for chips that can provide cheaper costs per inference compared to GPUs.

That said, it isn't likely that Alphabet is going to ever to take a huge amount of share away from Nvidia. However, even small share gains in inference workloads could be a big boost for Google Cloud. That's because TPU adoption would directly feed into Google Cloud usage as well. Google Cloud has been growing revenue quickly, with revenue climbing 28% year over year last quarter to $12.3 billion. More importantly, segment profitability has hit an inflection point, with segment operating income soaring 142% to $2.2 billion.

TPUs help boost Google Cloud's profits, not just by bringing in new customers but by lowering costs as well. And it doesn't stop just with chips. Alphabet has also developed all-optical switches that significantly reduce the power consumption and cost of TPUs. This gives the company strong operating leverage that the market currently isn't appreciating.

Image source: Getty Images.

Is Alphabet stock a buy?

Right now, Alphabet trades at a discount to other AI leaders, with a forward price-to-earnings (P/E) ratio of 18 times based on current year analyst estimates. Investors still largely view it as a search company whose core business could be disrupted by AI, while ignoring the big advantages in search it has with its distribution and global ad network reach.

They also underestimate the company's strong AI offerings. Gemini is consistently ranked as one of the top AI models in independent tests, and its app has seen downloads surge. It also has the best text-to-video generator on the market with Veo 3 and is incorporating AI features into its search offering. And let's not forget the company also owns the world's most-viewed streaming platform in YouTube, and its Waymo robotaxi business has been seeing strong momentum.

Alphabet's TPUs are another big potential growth driver. Nvidia's lead is massive, but if Alphabet can land a major customer like OpenAI and expand TPU adoption, it has a chance to become one of Nvidia's biggest competitors in inference in the future. And if that happens, Alphabet's stock should move meaningfully higher.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Geoffrey Seiler has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet and Nvidia. The Motley Fool has a disclosure policy.