Stock story: Alphabet

A dominant business with significant growth opportunities. (Reading time: 2 mins)

Stock story: Alphabet

January 2022

Alphabet is best known for its ubiquitous online search service, Google Search, which commands more than 80% of the global search market outside China. The company also owns YouTube, the largest global online ad-supported video platform on which more than two billion users watch more than one billion hours of content per day. It owns Android, and the Play Store for developers to distribute Android apps, which collectively support over two billion devices globally.

Alphabet has five other online services with more than one billion users – Google Maps, Chrome, Gmail, Google Photos, and Google Drive. It also owns the Google Cloud Platform, the third-largest hyperscale cloud vendor globally after Amazon’s AWS and Microsoft’s Azure. Finally, the company’s ‘Other Bets’ segment houses a number of early-stage ‘moonshot’ projects; most notably, autonomous driving company, Waymo, which is arguably the technology leader in the nascent industry.

Of the more than US$250 billion in sales that Alphabet is expected to have generated in 2021, more than 80% is from advertising, and the majority of this is from Search advertising. Market dominance is a self-perpetuating pillar of the wide moat of the search business. Having the most users is a key competitive advantage as more users generate more revenue to cover the high fixed operating and capital costs, more users generate greater usage data to feed back into the service to improve it, more users drive advertisers to spend more time optimising their ads for your platform, and more direct traffic results in less revenue shared with distribution partners. In addition, Google is a highly customer-centric company, focused on improving the utility of the service, and ensuring that ad load does not hurt the user experience. Consequently, users generally like Google Search, and because it is free to use, it is difficult for new entrants to attract enough users to become viable.

Google Search’s share of the global advertising market is more than 20% and growing because it is able to deliver users with greater commercial intent than offline media, generating measurably higher returns for advertisers. The search business’s primary competitive risk is from the growth of vertical search competitors, Amazon in particular, but Google’s business is broader than e-commerce and has grown strongly despite Amazon’s steady rise. It also faces a risk from the rise of new computing interfaces such as digital assistants (e.g. Alexa). Alphabet has overcome the rise of new interfaces before. Apple is the prime example. Alphabet pays Apple well over US$10 billion p.a. for providing default search services on its devices (primarily the iPhone).

The greatest risk to Alphabet’s outlook is antitrust regulation. The company is facing dozens of lawsuits globally. It has been fined more than US$10 billion in total by the European Commission for antitrust abuses across Google Shopping, Android, and its online advertising tools. Notably, none of these cases, or the resultant behavioural changes, appear to have impeded the company. US governments have opened similar cases and US Congress appears focused on legislating on these issues though laws that restrict self-preferencing (e.g. not being able to preference Google Maps in Google Search results) could be damaging to Alphabet in its largest market.

From an environmental, social and corporate governance perspective, Google is exposed to privacy concerns as it collects and analyses the data generated by its users to better target advertising at them. However, Search is less exposed to reductions in targeting ability than YouTube, because of the critical importance of the search input text to show relevant ads. Separately, despite the high energy use of its global data centres, Alphabet has been carbon neutral since 2007 and intends to run entirely on renewable power by 2030.

Overall, Alphabet is a high-quality business that stands to benefit from the continued shift to digital life.

Sources: Company filings and website


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