Under the Spotlight Wall St: Alphabet (GOOGL)

Today Google is practically synonymous with search engines, but it didn’t start life that way. Its rise to prominence wasn’t even the initial plans for founders Larry Page and Sergey Brin when they founded the company back in 1998.

Back then, the main online search service was Yahoo!, and Google’s plan was to grow just enough to be acquired for US$1m. You see, Larry Page and Sergey Brin were looking to get back to their PhDs after a sizable payday.

Yahoo! didn’t see the merit though, and even rejected an option to purchase Google for US$5b in 2002. Twenty years later, the market cap of Alphabet, the holding company that controls Google, has soared more than 300x, while Yahoo! has been sold for parts. Alphabet commands 80% of the U.S. search engine market and 94% in India, its largest market. It’s power is such that google is now a recognised verb in the dictionary.

A Tech Berkshire

Alphabet ($GOOGL) hasn’t gone it alone though, the company has had considerable help in building its presence thanks to a series of strategic acquisitions. In its 24 years of existence, the company has executed more than 250 mergers and acquisitions. These purchases have been so successful that the company has a remarkable similarity to Berkshire Hathaway ($BRK.A), rather than fellow tech giant Apple ($AAPL).

The most notable acquisitions made by the company are YouTube, Android, Waze, Boston Dynamics and Waymo. The darling of the bunch is clearly YouTube. Google purchased the company in 2006 for US$1.7b. Back then YouTube was in a crowded field of companies vying for a majority in the online video segment. Making matters worse, the company did not have a clear business plan. But the risk paid off. In the first quarter of 2022, YouTube generated approximately US$6.8b in advertising revenue alone.

But where there are winners, there are losers. One of the most famous examples was Google Glass, augmented reality glasses that could take pictures and record videos. The product never found an audience but is still produced by Google. Meanwhile its self-driving car company, Waymo, still doesn’t have a tried & tested business model.

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The Cash Cow

Despite the wide range of acquisitions made by Alphabet, the overwhelming majority of revenue for the company comes from advertising. As of the first quarter of 2022, US$54b out of US$68b in total revenue was generated from advertising. The remaining came from other Alphabet services (US$6.8b), cloud computing services (US$5.8b), and “other bets” (nomenclature used by Alphabet) accounting for just US$400m.

Undoubtedly, Google is the top of mind online search engine in most of the world, but there is still room for growth and market share gain. Not only in countries like Russia and China, in which the company holds 45% and 8% of the search engine market, but also in the mobile segment. The large number of iPhones sold ends up harming the company’s dominance in the smartphone segment, but the scenery seems to be changing quickly. In 2013 less than 30% of searches from cell phones were done through Google, now that number is over 60%. The number of app downloads from the Google Play Store has also been growing consistently, with more than 111 billion downloads in 2021 alone.

Growing Up With The Little Ones

As the saying goes, children are the future and when it comes to Alphabet and its subsidiaries like YouTube, they are the future of growth. Not only is the most played video in the history of the platform the children’s song Baby Shark (10b views), but the platform’s highest paid producer, MrBeast ($54m in 2021), focuses on younger (not children) audiences.

Focusing on the younger generations does not come without risks. In Alphabet’s case, the risk comes in the form of regulators attempting to ensure children are not exposed to improper content or bad actors. While this sounds straightforward, it’s anything but and it’s fair to say neither the regulators or Alphabet have found the best course of action. Unfortunately for Alphabet, this means the company has recently been under increased regulatory scrutiny. Google’s investment with regulators peaked in 2017, when it spent US$5.9m on lobbyists, since then it has fallen annually to now sit just under US$2m.

Getting Cloudy

With a Return on Equity (ROE) of 30%, revenue growing at an average of 22.5% over the last five years and a net profit margin of 27.5%, Alphabet has consistently been a darling of investors. Over the last two years, the company has only disappointed once, in the first quarter of 2022 with the culprit being low growth in Alphabet’s cloud computing segment.

The cloud computing segment is known for having high profit margins, but Alphabet has only 9% market share, having to compete with well-capitalised giants such as AWS (Amazon | $AMZN) and Azure (Microsoft | $MSFT). Together they have over 50% of the cloud market, a market that moves US$1.3t per year.

Estimates for the Alphabet’s full year 2022 revenue are approximately US$299b, but the global macroeconomic scenario could dampen demand for advertising if we head into a global recession. Combine this with slow growth from the cloud computing segment could again weigh on the company’s shares. It’s still too early to determine if this rain cloud could cause a thunderstorm or if it’s just a passing cloud, but Alphabet will soon find out.

This does not constitute financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.