On August 10, 2015, Google announced plans to create a new holding company, “Alphabet Inc”. The market took it exceedingly well and Google stock traded up 5 per cent the next day in a wobbly market adding some $US20 billion to its market capitalisation.
Essentially Alphabet will hold two entities:
1. Google: The internet businesses such as search, ads, maps, apps (i.e. Google Play), YouTube, Android, etc and the related technical infrastructure
2. “Google X”: The businesses that many consider as startups/experiments or “moon shots” as some commentators have labelled them (such as Nest, Fiber, Calico, and Google X, as well as Google Ventures and Google Capital).
So what does this mean for shareholders and those interested in Google as an investment? Does this change our investment thesis on Google?
I put a buy on Google on December 22, 2014 at $US516.00 (see Searching for value in Google). The share price is now $US612, up some 19 per cent.
The main investment case for Google was based on the company successfully monetising its transition from desktop to mobile ads and the expansion of YouTube.
Some analysts now predict YouTube will reach $US11 billion in revenue next year. With Twitter trading at six times projected 2016 sales, that conservatively makes YouTube worth about $US60bn. (Google paid $US1.6bn in 2006 for YouTube.)
In subsequent earnings reports since I recommended the stock Google has continued to deliver.
I see a number of “takeaways” from this announcement:
- With a holding structure and separate CEOs for each business, the new structure should provide investors with greater overall transparency as well as create a greater entrepreneurial atmosphere and autonomy for all of the Google X businesses. Capital allocation will remain at the holding company level however and that’s a positive.
- Alphabet management will look similar to Google’s today with Larry Page as CEO, Eric Schmidt as executive chairman, and Ruth Porat as SVP & CFO. Sergey Brin will become President of Alphabet, while Ruth Porat will also serve as the CFO of Google.
- The most important management change here is the ascension of Sundar Pichai as Google’s CEO, a very capable guy and the driving force behind Google Chrome and the expansion of the Android operating system into new areas. As head of “products” he was also responsible for oversight of Google’s main businesses – maps, search and advertising.
There will be new segment disclosures published as part of the 4Q15 results. Investors are likely to shift their valuation methods for Alphabet to a sum-of-the-parts calculation (SOTP) valuing Google as a significant generator of cash and Google X as a high-growth investment vehicle.
How will this impact valuations? It’s really too early to tell but I suspect it will be positive. Google received a number of Wall Street upgrades on the news.
Does this pave the way for Alphabet to be two separate companies? Unlikely, in that Google's cash flow is necessary to support Alphabet's other operating companies.
Shareholders should experience a pretty seamless transition. Alphabet will become the publicly traded entity and corporate name, but GOOGL and GOOG will continue to trade as they are, encompassing all components of Alphabet.
While we have referred to some of the Google startups in previous reports, maybe now is the time to have a closer look at some of the more high profile entities.
Hopefully under the new structure we will receive more concrete data on the emerging businesses including financial performance.
A manufacturer of home automation products especially programmable, sensor driven thermostats, smoke detectors, and security devices. A promising IoT (Internet of Things) company.
A fiber to the premises business providing broadband, internet access and cable TV to subscribers in selected areas in a number of major US cities (Kansas City, Austin, Charlotte, Salt Lake City, San Antonio etc). Faster (100 mb/sec) and cheaper than many of its competitors. Some analysts have predicted 8 million subscribers by 2022.
An independent biotech research and development company with the goal of combatting aging and related diseases by using advanced technologies and techniques. CEO is legendary Genentech chairman, Arthur D. Levinson.
Self-driving autonomous cars
A Google X project developing technologies for fully autonomous automobiles. Google vehicles have now successfully covered over one million miles. Google could either manufacture an automobile (a la Tesla) or monetise the technology.
Headed up by the appropriately named Astro Teller, it is actually is a place – the “semi secret” research centre that is overseeing some of Google’s more audacious potential technological breakthroughs such as Google Glass (version 2 coming soon), Loon (high altitude balloons to deliver the internet), Project Wing (UAVs/drones for package deliveries), Contact Lenses (contacts that measure blood sugar for diabetics), Makani Power (air borne wind turbines), Lift Labs (life science diagnostics), Baseline (analysis of medical and genomic data to define the healthy human body), Nanoparticle Platform (nanoparticles that detect disease) and Google Neural Network (computers assembled in an network that can learn. Can recognise cat videos on YouTube!).
Google’s venture capital arm provides financing/seed capital to promising startups.
Invests for profit only in late stage high growth technology companies. Currently focusing on big data, cyber security, financial technology, and e-learning. Recent successful investments include Survey Monkey and Lending Club.
Looking at fundamentals
The beauty of the new structure is that it will allow Google to more easily spin off the most promising entities thus crystallising their value for Google and investors.
As well, investors should get a clearer picture of revenues, cash burn, profitability etc in the Google X stable of companies.
I believe that Google’s fundamentals are solid and that the company will be prime beneficiary of the ongoing shift to online spending. I think it’s still relatively early in Google’s monetisation of mobile search ads and I expect mobile pricing to converge toward desktop levels over time due to greater targetability, including location-based attributes. Note following chart – it’s early days in almost every market and only 16 per cent in the US, the biggest market!
I also predict that YouTube will capture more video dollars shifting online, and that Google Play strength will continue. With 2014-2017E CAGRs for revenue and profits ranging between 17-20 per cent, Google remains a buy.
I see more upside for Google and so I am raising our price target to $US800. That is based on based on 19 x 2017EPS (which should be in excess of $US43/share). At 19 x 2017EPS Google’s PE to growth (PEG) ratio is 1.05x, which is below or in-line with large-cap peers and certainly not excessive.