Alphabet is facing pressure on two fronts--the government and AI--but will prevail. Its stock could gain 50%. By Al Root
Google is under attack. Alphabet stock will still emerge a winner.
Alphabet shareholders have every right to be worried. This past week, the U.S. government hit Google -- and hit it hard -- when it put forward remedies to break Google's hold on search, which included selling its Chrome browser and monitoring data, causing the stock to fall 4.7%, to $167.63, on Thursday. The action comes as investors were already fretting about the rise of generative artificial intelligence -- computers capable of answering complex questions in, mostly, plain language -- which have created an opening for competitors like ChatGPT, Perplexity, and Microsoft in a way that Yahoo! and DuckDuckGo never could. Not only can they siphon users away from Google, but the search for answers instead of links also could be devastating for its advertising business. Without search and the ad dollars it produces, the mighty Alphabet collapses -- and so does its stock.
Alphabet, however, is more than up to the task of defending itself. Since going public in 2004 -- at a split-adjusted $2.13 a share -- Google has navigated the shifting terrain of the internet, including the transition from desktops to mobile phones, with relative ease. While the future will be more complicated, generative AI has the potential to add revenue, as Gemini, Google's AI tool, ramps up and becomes more powerful. While the government's attempt to break Alphabet apart could be an overhang, it appears to be reflected in the stock, which is the cheapest of the Magnificent Seven and even cheaper than the S&P 500 index. Even as that future unfolds, the company's search business remains dominant -- and cash-generating -- and that is unlikely to change, even as the way people find information does.
"I don't see betting against Google," says Jason Browne, president of Texas-based investment advisory firm Alexis Investment Partners.
For two decades now, Alphabet has been a winner. Its advertising business generates more than $250 billion annually, while Android has become the world's most popular mobile operating system, easily surpassing Apple's iPhone in users. Following the lead of Amazon.com and Microsoft, Alphabet moved into the cloud, which is expected to generate $58 billion in revenue for the company next year. At the same time, though less talked about than TikTok, YouTube has become the planet's No. 1 content delivery platform, with viewers watching more than a billion hours daily.
The rivers of cash generated from all of its units -- some $435 billion over the past decade -- have allowed Google to indulge in what it calls its "other bets," including Waymo's self-driving car initiatives and Google Fiber broadband internet, money-losing businesses that investors simply ignore. And it's all tied together by Google's search engine, creating an aura of invincibility and inevitability.
Then, ChatGPT launched in November 2022. Generative AI, with the ability to scrub the net and provide easy, if sometimes dubious, answers, opens up a new possibility for accessing data -- and a new threat to Alphabet's dominance. Users no longer have to type questions into Google's search bar and scroll through links. Now they can type in a question and get an answer. ChatGPT was mind-blowing when it arrived -- and an immediate success. "It was the fastest [growing], most exciting app that has ever hit the market," says Futurum Group CEO and technology researcher Daniel Newman, who noted that it reached 100 million active users just two months after its launch.
Perplexity, launched a month after ChatGPT, has grown to 15 million monthly active users and recently launched a shopping assistant, allowing users to type in a question, get an answer, and execute a transaction. Dmitry Shevelenko, Perplexity's chief business officer, calls the company's tool an "answer machine," one that gives users the information they need versus just giving them links. Perplexity answered about 425 million questions over the past 30 days, up from 500 million in all of 2023. Ultimately, the company hopes to create an all-in-one app, where users can act on what they have learned and never have to leave.
These changes seem ominous for Google. Follow them to their logical conclusion and it isn't hard to imagine traditional search fading away and the market fragmenting, with consumers one day communicating with their devices via an AI-generated custom interface. In February, technology research firm Gartner projected that total search engine volume would drop 25% by 2026. There's only one problem with those dire predictions -- the data don't back them up. Microsoft was the first mover, putting ChatGPT into Bing, while boldly claiming that taking 1% of search market share would translate to $2 billion in incremental revenue. "Microsoft took no share," says Futurum's Newman.
What's more, Alphabet's October earnings report showed no signs of a search slowdown. It easily topped earnings and sales forecasts, while revenue from its cloud business gained 35%. But it was search that was perhaps the most surprising. Anyone who visited Google recently noticed that the service often provides an AI-generated summary of the findings, as well as a list of links. Investors had worried that would mean fewer links and ads, but management appeared optimistic about its ability to make money from those searches.
"We still have no idea how they'll really monetize AI or other innovations, but the perceived 'threats' (OpenAI, Meta AI, Perplexity, and upcoming Meta and OpenAI search) will have to wait, as Google Search growth of 12% beat estimates modestly," writes Melius analyst Ben Reitzes.
Alphabet has something going for it that OpenAI, which has a partnership with News Corp, the owner of Barron's parent Dow Jones, and Perplexity don't -- it's a moneymaking business. The two start-ups are still in the early stages of their business development and aren't profitable. How they ultimately monetize their businesses -- and whether they can successfully do it -- remains to be seen. Perplexity is also being sued for not paying for the content it feeds into its large-language models, or LLMs, something that could ultimately force it to change how it operates. (Dow Jones is one of the companies suing Perplexity.)
While the upstarts try to figure things out, search should keep growing. Media investment and data-services provider GroupM projects that search advertising revenue will grow more than 6% in 2025, up from about 5% in 2024, with about 5% average annual growth through the decade's end. It isn't that people like to click through a list of links produced from a query, but that AI-assisted search will produce better results, leading to more questions and further searches. Rather than being a paradigm shift like the switch from desktop to mobile, AI search may be a new format for answers, says New Street Research analyst Dan Salmon. "[It's] more akin to the integration of images, maps, and other forms of content beyond the original text links," he explains. Salmon rates Alphabet stock a Buy with a $213 price target.
The advent of AI is also likely to create new types of search and novel ways to earn money from sifting through information. There is the traditional ad-supported version -- now with AI summaries -- that Google dominates, and premium tools are available by subscription. There are even tools being created for individual companies, such as GE Aerospace's ChatGPT-powered Wingmate, which uses LLMs to provide relevant answers to the questions from the company's engineers based on design and operating manuals. Now, imagine every company in the S&P 500 doing the same thing. "Search behavior already moved to a dual revenue stream: subscriptions and ads," Salmon says.
Alphabet is playing in both pools. Google One has over 100 million subscribers, and its premium version includes Alphabet's highest-level AI functionality for $20 a month. ChatGPT's premium product has about 10 million subscribers, Salmon estimates. Alphabet also has the advantage of experience, including years of work with its Google Brain and DeepMind AI projects and its internally developed Tensor AI hardware. And it recently purchased character.ai for $2.7 billion to help with these efforts. It has the advantage of $154 billion in operating cash it is expected to earn in 2025 as it gets ready to spend $59 billion on its AI future, similar to what Microsoft spends a year.
That spending should pay off. Salmon estimates that generative AI overviews and subscriptions keep Alphabet's Google business growing at about 10% a year on average through 2027. "New AI features in search are resulting in better engagement and higher levels of user satisfaction," says Wedbush Securities analyst Dan Ives, adding that structural risks to Google's search dominance are overblown. Wedbush rates Alphabet shares a Buy and has a $210 price target.
AI might not be able to slow Google down, but the antitrust risk is real, as this past week's decline demonstrates. In August, U.S. District Judge Amit Mehta ruled in favor of the Department of Justice, saying that Google illegally monopolized search. This past week, the DOJ proposed a list of remedies that include selling the Chrome browser, prohibiting the ownership and control of anything that creates a preference for Google, and "restoring competition through syndication and data access" -- essentially requiring the company to provide its core search index to anyone who wants it to label as their own free of cost.
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November 22, 2024 21:30 ET (02:30 GMT)
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