Why the Alphabet Is Its Own Worst Enemy
Alphabet (GOOGL -3.40%) (GOOG -3.40%) recently became the fourth company to reach a market cap of $1 trillion. It reached this milestone less than 22 years after its inception by dominating the internet in search and branching out into videos, smartphone operating systems, cloud products and many other offerings. Considering all the apps the company invented, it created perhaps one of the most successful research and development teams in the company’s history.
However, its prosperity may have also hindered some of its success. Alphabet’s corporate structure may have prevented some divisions from realizing their full value. By splitting divisions or permitting a breakup, Alphabet could add considerable value to its shareholders.
Who is Alphabet?
The company remains best known for its original product, the search engine. However, Android, YouTube, as well as many companies in other companies are also shaping the business. Yet Google Sites, which includes the advertising platform that has long generated the bulk of the company’s revenue, accounted for more than 70% of Alphabet’s revenue last quarter.
Alphabet has also earned a reputation as an innovator. Their success in this area has led The Boston Consulting Group will classify Alphabet as the most innovative company in 2019, taking the title of Apple.
Today, Alphabet consists of dozens of subsidiaries. This includes life science companies such as Calico and Verily. Google Fiber, self-driving car company Waymo and technology incubator Jigsaw are also among the list of companies under the Alphabet umbrella.
This diversification has helped the conglomerate in a key area. As Facebook and Amazon claim a growing share of ad revenue, the company has shifted away from ads. Therefore, much of the focus is on what society classifies as “other” income. This includes Google Cloud, as well as Google Play. This division developed 39% year over year last quarter to $6.4 billion, or about 15.9% of company revenue.
As mentioned earlier, Alphabet started by creating its innovative Google search engine. This site quickly became the most popular website for searches, and today it still retains over 92.7% of the global search engine market. Android has a global market share of approximately 85% of the OS market for smartphones, as YouTube brags over 2 billion monthly active users
In the United States, the Department of Justice (DOJ) scrutinized the company because of its search dominance, and its data collection supplemented by YouTube and Android created a so-called anti-competitive market in this space. More recently, the DOJ also raised concerns about Alphabet recovery project of Fitbit.
A number of state attorneys general sued, and EU regulators have also been investigating the company. The EU has fined the company a total of $9.4 billion over the past three years due to anti-competitive practices.
The case for unlocking value
Alphabet’s legal team continues to fight these charges and any attempts to break up the company. So far, investors don’t seem worried. Alphabet’s stock has been rising steadily since the DOJ first announced its probe. It continues to maintain a market capitalization just above $1 trillion.
Yet despite the recent surge in Alphabet shares, fighting a breakup may not be in shareholders’ best interests. Given the history of breakups, one has to wonder if investors should encourage the company to stay together. Two significant breaks, standard oil and the original AT&T leads to the sum of the parts becoming much greater than the whole.
This could also become the case with Alphabet. Morgan Stanley Waymo values at around $105 billion, or just over 10% of Alphabet’s current market capitalization. And that’s just one of many divisions. The company’s balance sheet does not seem to reflect this value well. Last quarter, Alphabet reported a total of $19.8 billion in intangible assets.
That’s not to say Alphabet should sell every division. Even the spin-off of a non-core division such as Waymo could bring further challenges. Alphabet faces competition from Nvidia, Intel, and others in the self-driving car market. Without Alphabet as a benefactor, it would not only lose a key source of funding, but perhaps a competitive advantage.
Yet, as mentioned earlier, the business needs non-ads revenue streams. With Google Cloud and Google Play fulfilling this obligation, they don’t need all of their current subsidiaries to support growth.
Also, the company’s cash flow could play a vital role in unlocking some of its value. Alphabet held about $121 billion in cash at the end of the last quarter. This makes Alphabet the largest non-dividend paying company in the world. Offering a cash payment could open Alphabet up to a new group of income investors, driving the stock price higher.
Alphabet has achieved unprecedented success in developing compelling apps across multiple industries. These will continue to generate significant growth for years to come. However, by giving away some of that value, more of that growth can flow back to holders of Alphabet shares.