To The Moon

Alphabet Inc. (GOOGL) is the holding company of Google, a tech giant offering a wide range of technological products in the likes of search engine, maps, calendar, mail, operating system. GOOGL also sells hardware products and online advertising services. GOOGL’s reporting segments are Google Services, Google Cloud, and Other Bets. In terms of global market share for search engine, GOOGL has 92%.

Investment Overview

Google Service operating margin to drive the stock price. The high performing segment in GOOGL is the Google Services segment which generates pre-pandemic level margin of 32%. GOOGL’s Services segment is expected to record similar margins given the scale in Search (64% of service revenue), YouTube (12%), Third-party ad-tech revenue (13%) and others. Search is critical to drive this growth as it continues to be the fastest growing segment (4% y-o-y vs 2% y-o-y revenue growth in the Service segment). Consensus projects Google Services revenue to grow at a CAGR of 9% during FY22F-25F.

GOOGL’s Cloud Platform (GCP) margins have a big room to improve. GOOGL’s cloud segment has significant growth potential. Its operating margins narrowed from -14% to -10% in 3Q22 with a revenue of US$6.9bn (+38% y-o-y). When AMZN recorded similar revenue levels in cloud during 2018, the operating margins stood at 28%. While the market is more competitive today, there is tremendous room for margin improvement. Global enterprise spending on cloud infrastructure services grew 28% y-o-y to US$63.1bn in 3Q22. AWS accounted for 32% share of this global market while AZURE and GCP accounted 22% and 9% respectively. The annual growth rate fell below 30% for the first time due to macro uncertainties and the cloud segment might see some slower growth in the near term. GCP is still way behind AWS and AZURE in terms of operating margins of 30% and 45% respectively. It should certainly be possible for GCP to increase operating margin to 20% by 2025. At this rate, the operating income for GCP would be US$11bn on a revenue base of US$55bn. Consensus estimates GCP revenue CAGR of 28% over FY22F-25F.

Some positives for GOOGL’s ad segment due to cookies. GOOGL decided to delay the phasing out of third-party cookies to 2H24F (previous early FY22F). This could offer GOOGL a targeting advantage to its ad-tech business (accounts for 13% of 3Q22 service revenue) because GOOGL can offer alternative targeting capabilities (Privacy Sandbox solutions) to advertisers and publishers, claiming they can be 95% as effective as cookies, and the timing change will enable these solutions to be further tested and accepted by industry. Privacy Sandbox solutions would mainly address the user privacy. The two proposals are 1) Same site-help browsers identify third-party cookies 2) Privacy Budget- limits the use of information so sites can’t collect enough information to identify an internet user personally.

GOOGL’s share price has been susceptible in the past due to revenue growth and margin trends and this could be impacted by further deterioration in macro-economic conditions. Other downside risks include mobile transition triggering negative search behavior changes, revenue growth pressure from competitor initiatives, margin disappointment owing to revenue mix and investment initiatives, and negative regulatory changes.

Given the recent developments, I am slightlybearish about Google. I feel the job cuts may not be sufficient to lift its revenues up. It is still facing stiff competition.

@TigerStars 

DYODD