Alphabet Inc (GOOG/GOOGL) – Woodbridge Capital Management

Introduction

Alphabet (“GOOGL”) is a fantastic business, with minimal capital requirements, a strong moat and a debt-free balance sheet. They have one of the strongest monopolies I am aware of, with somewhere around 90% market share in their core market — search.

GOOGL has grown revenues at ~20% compounded over the last 10 years, with plenty more room for growth still ahead.

Considering the quality of the business and growth potential, GOOGL is undervalued even at ~28x TTM earnings.

The below table shows the components of GOOGL’s business and their contributions to revenue for the last 12 months:

Google Search & other	57.50%
YouTube ads	11.33%
Google Network Members’ properties	12.46%
Google other	11.10%
Google Cloud	7.31%
Other Bets	0.32%
Hedging gains (losses)	-0.02%
Total revenues	100.00%

GOOGL derives 81% of their revenues from Internet advertising on their sites as well as partners’ sites. With an estimated 5.6 billion Google searches conducted every day, there is probably no more effective form of advertising.

Other primarily represents revenue GOOGL generates from:
- Google Play, where GOOGL receives a percentage of developers’ app sales
- Hardware, such as phones, Chromebooks, etc.
- Subscriptions to YouTube and other services

Cloud represents revenue from Google Cloud, GOOGL’s cloud computing service which competes directly with Amazon’s AWS (#1 in global cloud revenue), Microsoft’s Azure (#2), and Alibaba Cloud (#4).

Other bets includes various start-up type businesses that are expected to be high-risk, high-reward investments, such as Waymo.

Search

Search has been the engine of GOOGL’s growth since inception, though it has slowed down somewhat in recent years. With search becoming a more mature market in the U.S. and no opportunity for market share gains, it is unlikely GOOGL will see the same growth rates it has in the past.

However, upon reaching $2 trillion market cap GOOGL’s CEO Sundar Pichai stated that the next trillion would come from search as well, and there is reason to believe him.

As GOOGL expands its data and improves its search algorithm to become more useful (for example Google provides weather and stock info now), it is not unreasonable to see search volume continue to grow modestly in the U.S. However, I anticipate that emerging markets will be critical to GOOGL’s future growth. India alone has 4 times the population of the U.S. As more people gain access to the Internet and as advertising budgets grow, GOOGL should benefit for many years to come. Moreover, GOOGL’s market share is higher in emerging markets because their devices are cheaper than those of competitors, which brings me to my next point.

Other

With respect to operating systems for mobile devices, users essentially have two choices: Apple or GOOGL’s Android. Android is the #1 OS globally, on 2.8 billion devices, representing 75% market share.

Chromebooks have also increased significantly in popularity in recent years. With their respectable hardware, compact size, and price just a fraction of competing laptops, Chromebooks offer serious bang-for-your-buck. They have become very common, for example, in schools both domestically and abroad. In 2020, Chromebooks outsold Apple computers for the first time and have begun eating into Microsoft’s market share.

The same trends that favor search should continue to benefit Google Play revenues and hardware sales.

Cloud

GOOGL’s cloud business should be able to expect continued high rates of growth over the medium term, with the global cloud market projected to do ~18% CAGR through 2028.
Cloud computing is a technology with virtually unbounded potential, and GOOGL appears uniquely positioned to reap the benefits. In the future I see no reason why virtually all computing will not be cloud-based – from business to personal to gaming, at which point there will no longer be a need for anyone to spend money on pricey, powerful computers, servers or gaming consoles. Instead you will be able to use an inexpensive Chromebook to access the world’s most powerful computers for a low monthly subscription. The only limiting factor right now is Internet speeds.

Other Bets

For GOOGL’s other bets, it is difficult to say what the growth rate there might be, but they do have a solid track record with their acquisitions. GOOGL paid $1.65 billion for YouTube in 2006. Not bad for a business that generated over $30 billion in revenue TTM. For Android, GOOGL paid only $50 million for what is now the world’s #1 OS by device count and has generated tens of billions in profits for GOOGL.

Perhaps the most significant among GOOGL’s other bets currently is Waymo, the most advanced self-driving service and the only one that operates without safety backup drivers in the vehicle. Waymo is open to the public in Phoenix, AZ and for testers who sign up in San Francisco. Waymo plans to expand to New York City as well, with mapping that began in November.

GOOGL’s valuation does not depend on the success of any of their other bets, but Waymo is a nice call option on the future of autonomous driving and robo-taxi services.

GOOGL’s past growth has been consistently tremendous, and, if the next decade is anything like the last, then GOOGL should turn out to be an excellent investment. Over the last ten years, GOOGL’s revenues increased 531%. If it were to achieve even a third of that growth over the next ten, it would represent a 10.7% CAGR. While it might seem that there is not much left for GOOGL to conquer, consider the fact that 10 years ago GOOGL’s dominance in search was already well-established. Yet they have continued to grow rapidly along their core channel as well as new avenues.

GOOGL has an enterprise value of $1,757,395 million with $85,021 million of pre-tax income for a TTM EBIT/EV of 4.84%. With an earnings yield that is average or above and growth potential that is well above-average, GOOGL is a clear bargain. Management thinks so too, having put ~75% of their FCF into share repurchases YTD.

The largest real concern I can think of is that GOOGL is too good: lately they have begun to draw the ire of antitrust regulators in the U.S. and Europe. While they might experience fines and scrutiny, I think the prospect of GOOGL being broken up is unlikely.

There is also the fact that Larry Page and Sergey Brin control the majority of the company’s voting stock, but I believe their ownership is enough to align them with shareholders and that the company is too much in the public eye for any self-dealing.