Narratives are currently in beta
Meaning
During the tech bubble of the late 90’s, Larry Page and Sergey Brin founded Google which later went public in 2004. Larry and Sergey’s founding motto, “Google is not a conventional company. We do not intend to become one” continues to guide decision making. In 2015, Google and its subsidiaries reorganized under the new parent company name of Alphabet Inc.
Alphabet reports business activities under three separate divisions:
- Google Services – 88% of revenues
- Google Cloud – 12% of revenues
- Other Bets – <1% of revenues
Google Services is comprised of the Company’s most widely known products. “Google Services' core products and platforms include advertisements, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Google Search, and YouTube.” The Services division makes money in the following ways:
1. Advertising (Google Search, YouTube, and Google Network) – 87% of Google Services’ revenue
- Google Search Ads = 65% of Google Services revenue or 57% of total revenue
- YouTube = 12% of Google Services revenue or 10% of total revenue
- Google Network = 10% of Google Services revenue and 9% of total revenue
2. Google Play Store generates revenue from sale of apps and in-app purchases
3. Hardware revenues are generated through the sale of Fitbit devices, Google Nest home products, and Pixel smartphone devices
4. YouTube non-advertising generates revenue by selling subscriptions to YouTube Premium (ad free platform) and YouTube TV (live TV streaming service)
Nearly 90% of Google Services’ revenue is generated through advertising on their digital platforms. Alphabet is susceptible to macro-economic conditions as advertising tends to be one of first expenses the market seeks to cut and expand during economic cycles.
Google Cloud generates about 12% of Alphabet’s revenue through the sale of its products including data security, data infrastructure and analysis, and Google Workspace (Gmail, Google Docs, Google Maps, etc.)
By the nature of Google Cloud’s product types, it primarily sells to enterprise customers on a subscription basis. Google Cloud had its first ever quarter of profitability in Q2 of 2023 and has been growing quickly in both revenue and profitability. Alphabet recently made the news (July 2024) with plans to acquire Wiz, the third largest player in cloud cyber security, for a whopping $23 billion. This deal has yet to finalize and could be subject to intense regulatory scrutiny but could add substantial revenue to the cloud business – Wiz has been growing its revenue by triple digits (100%+) every quarter since its inception in 2019 and currently is at $350 million in annual revenue. A $350 million injection would only be a 1% increase to Cloud’s revenue. Clearly, management believes Wiz’s revenue will continue growing at astronomically high rates and may benefit dramatically from synergies with Google Cloud’s existing platform and client base.
Other Bets includes a multitude of side projects like Waymo (self-driving cars). Alphabet funds its “Other Bets” as it strives to innovate and continually seek another “home run” product offering. The revenues generated by Other Bets is nominal in value relative to Google Services and Google Cloud.
Despite impressive growth in Advertising (16% annually since 2017), Alphabet’s revenue and earnings streams have slowly become less dependent on advertising.
Moat
Alphabet benefits from multiple different competitive advantages. The most obvious being their extreme brand awareness in the web browsing space. Multiple statistic reporting websites, including Statista.com and StatCounter.com, claim that about 90% of the global search engine market share goes to Google Search while Microsoft’s Bing search engine has the next highest share at less than 3%. Clearly, Google’s brand image is unrivaled. While Alphabet boasts monopolistic numbers in this space, it cannot claim monopoly power as a competitive advantage in the legal sense - there is no intrinsic characteristic about the product that requires a customer to use Google Search rather than an alternative search engine. However, because Google Search is such a dominating force in a massive industry, regulatory institutions continually seek to disrupt this competitive advantage. The latest attempts made by the US DOJ involved attacking Google’s deal with Apple to be the default browser on Apple devices. Despite these challenges, Google Search’s extreme brand awareness is likely strong enough that it wouldn’t see a material change in users even if new iPhone owners were given a choice of their default browser – virtually everyone would elect to set Google as the default.
Both Google Search and YouTube leverage a networking effect competitive advantage. As more people send searches through Google’s engine, its artificial intelligence becomes better at producing relevant results. As the engine’s results improve, more people are likely to use Google Search – the cycle continues to build upon itself. Similarly, YouTube viewers draw content creators to the social media platform. As more content is created, more users spend time viewing the created content. Networking effects are so strong because they act as a snowball effect that is likely to continue uninterrupted in the absence of major changes taking place in the industry.
Together, these competitive advantages create an incredibly deep and wide moat for the Company. However, regulatory threats pose as a contra-moat to Alphabet. Investors should keep informed regarding government intervention that could degrade the effectiveness of Alphabet’s brand awareness and/or networking effects. Furthermore, Google Search is dependent on continuing to deliver quality results to user queries. This requires the company to constantly win its battle against spam which can dilute the quality of its search results. Keeping an eye on market share figures should give insight into the quality of Google Search’s product – if it begins dropping it could be a sign of a poor performance in battling spam which would deteriorate the company’s competitive advantages.
Artificial Intelligence (AI) has taken the tech world by storm over the last two years. Though Alphabet may not have been the organization to spark the AI revolution, Alphabet certainly has a competitive advantage in the AI space due to its Google Search networking effect - the quality of all software development is highly dependent on user data and interaction. This principle is magnified in AI language learning models (Gemini, ChatGPT, etc.) due to the nature of the product’s goal which is to mimic human capabilities and characteristics. Google Search provides Alphabet with a massive and ever-growing data set which can be leveraged to develop the highest quality AI products. Due to its “networking effect” moat, Alphabet likely won’t fall behind in the development of quality Artificial Intelligence products. Consider the following analogy:
Two equally skilled individuals are placed in separate rooms to complete the same puzzle. In Room A, the lights are turned on at full capacity, whereas Room B’s lights are only lit at 50% capacity. Who will complete the puzzle first, the individual in Room A or Room B?
The puzzle can be compared to the development of AI products while the amount of light can be compared to the amount of available data. Companies with more data are far more likely to finish first in the AI product development race the same way the individual with more light will be the first to complete the puzzle.
The true AI challenge presented to Alphabet’s management team will be their ability to navigate the monetization of AI products – if AI products begin to replace Google Search in a material fashion, will Alphabet still be able to profit from their new AI product(s) the way it has profited from legacy Google Search?
Management
Alphabet’s management team is considered experienced by SimplyWall.st with 6.3 years of tenure on average.
Sundar Pichai was elected as Alphabet’s CEO in October of 2015 after having spent several years as the “Google” segment acting CEO. Sundar’s pay structure gifts him a huge payout every three years. CNBC described management’s compensation as follows:
- “Pichai was awarded $218 million in equities last year through a triennial stock grant. His annual salary was $2 million from 2020 to 2022, the filing stated. The CEO’s compensation package also included almost $6 million for personal security in 2022. Other Alphabet and Google principal executives made approximately $22 million to $35 million in annual stock awards, according to the filing.The report comes as Alphabet is initiating cost restructuring measures, including layoffs in January which eliminated 12,000 workers, or 6% of its workforce. Google’s finance chief, Ruth Porat, announced earlier in April that the company would be cutting back on employee laptops and services to further reduce costs.”
Sundar is 49 years old and likely to continue as Alphabet’s CEO for an extended period as long as the company continues to see high returns on capital.
Sundar unfortunately does not provide a meaningful annual shareholder letter. His letter tends to be short-winded and focused on explaining the company’s successes. It does not make mention of difficulties the company faced over the year, let alone the specific action the company plans to take to manage present challenges.
Thesis Catalysts
- Continued steady growth of overall revenue (10% plus annually)
- Quarterly fluctuations are tolerable – don’t freak out if we see a slow growth quarter mixed in there
- Continued dominance in search services (about 90%)
- Continued rapid growth in Cloud revenue and earnings
- At least match the growth of the greater market, but would prefer to see Google Cloud taking market share
- Continued growth in YouTube’s ad revenue at about 10% year-over-year
How well do narratives help inform your perspective?
