Alena Kravchenko
The following segment was excerpted from this fund letter.
In early January this year – which admittedly feels like eons ago – US President Joe Biden was pushing Americans to take up the government’s offer of free COVID tests to help tackle the surging omicron variant. How did Biden respond when citizens asked about the availability of these tests?
“Google it!”1
This advice, undoubtedly well-meant, was roundly scoffed at by the press, however. It seemed too obvious to be very helpful.
Anyway, the anecdote serves to introduce you to one of our largest holdings, Alphabet; the parent company of Google. Note that first, Alphabet’s original and core product – its search engine – has entered our common vocabulary as a verb. ‘Googling’ something has the same meaning as ‘researching’ or ‘finding an answer to’ something. Second, the reason Biden’s advice was met with such opprobrium was because Googling something has become almost second nature to us now.
These two observations reveal a lot about Google’s strength in the search engine market, in which it has a share of over 90 percent. Because internet search is almost the prototypical network, Google has benefitted from – and we think is also protected by – the huge competitive advantage its scale brings – both to those asking the questions and those providing the answers.
The Google search platform becomes increasingly useful to anyone seeking information as a greater volume of stuff becomes available. This starts a virtuous cycle that results in a colossal market share for Google itself. In the language of business strategists, Google benefits from vast network effects.
Because Google’s search results are viewed by billions of eyeballs every day, its search page ‘real estate’ is understandably very valuable to those with goods and services to sell. Advertising revenues from this ‘real estate’ as well as that from its other properties such as Mail, Maps, and so on, totaled almost USD 150b in 2021; amounting to almost 58% of the company’s revenues.
Ad sales on YouTube, also owned by Alphabet, brought in another USD 28b. With the secular shift of the advertising spend to digital channels – over which Alphabet has a tight grip – we estimate the company has a share of around 40% of the digital advertising market and is probably the most valuable advertising property in the world.
The final piece of Google’s advertising ecosystem is its suite of products such as AdSense, which it provides to website owners wanting to sell advertising space on their properties. We estimate that Google pockets about 33 percent of every $1 in the advertising sales generated by these partner websites. By having such a lengthy list of advertisers looking for space, Google is able to match advertisers with website owners for their mutual benefit.
Altogether, Google’s various advertising businesses pull in over four-fifths of the company’s revenues, and are hugely profitable, with operating margins consistently above 25% and returns on invested capital clearing 20%, and that’s after capitalizing research & development costs.
While Google itself represents the largest chunk of Alphabet’s business, there are a couple of other businesses worth mentioning – Google Cloud and Other Bets.
Alphabet came late to the Cloud game, with the public roll-out of the Google Cloud Product in 2013, some seven years after Amazon (AMZN) had released AWS and three years after Microsoft (MSFT) launched Azure. As a latecomer, Google is up against two behemoths in the form of Amazon’s AWS (which made USD 20b last quarter versus Google Cloud’s USD 6b) and Microsoft’s Azure (which made an estimated USD 12.5b last quarter).
Given the fixed cost nature of running a business like this, Google Cloud Product is still making a loss, though given the strong growth (sales have more than doubled over the past couple of years), losses are narrowing, and the business is expected to break even in the next year or two.
Meanwhile, the more skeptical observers have described Other Bets, also part of the Alphabet empire, simply as an expensive hobby. Other Bets may be viewed as a VC-type accelerator that invests in small (usually loss-making) businesses that could become material to the company in the future. This division is serially unprofitable, but the losses barely move the needle for Alphabet as a whole.
Other Bets’ ventures range from the artificial intelligence company DeepMind – now very profitable from private company accounts – to the smart home appliances company Nest, to self-driving pioneer Waymo. It’s worth noting that DeepMind, according to its private company accounts, pulled in over GBP 100m in net profit last year, a doubling from the year before.
We are not technologists and cannot say which of these will be profitable in the long term. But innovation doesn’t happen in a straight line and given the natural tendency for huge (and hugely profitable) companies like Alphabet to rest on their laurels, at least they’re not getting lazy.
Footnotes1 To be precise, he said: “Google…COVID test near me…to find the nearest site where you can get a test most often and free.” |
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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