Google – The Bear Case

by current-asscoverer

Summary

Ad revenue growth is slowing down and I expect this trend to continue.

That’s Google’s core business, which means the company will be forced to explore other avenues to maintain growth.

Cloud, Youtube, and Waymo will provide some future growth. But will it be enough?

Thesis

Alphabet, Inc. (GOOGL) has been an outstanding company and investment for the better part of 20 years. Its search engine is unparalleled and there is little chance of it getting displaced any time soon. Nonetheless, its main source of revenue; search engine ad spending is beginning to taper off. With stiff competition, there is an inherent risk in Google which many investors may not be factoring into their analysis. Below we develop the bear case for Google.

Google’s core Business

There’s probably not an adult human in the world that doesn’t know and understand how Google makes money. It’s all about the ads. When searching for anything on the internet, you are going to use google and in most cases, you will be looking at the first few results on the first page. The importance of featuring high up on a google search has turned SEO and SEM into a billion-dollar business in and of itself. But there’s a much easier way to guarantee a top spot and that is paying Google, and it doesn’t stop there. Google also has ads all over the web in the form of “banners” and the like, and because it knows what you are searching, it knows which ads to show you.

There’s no doubt that Google ads are effective but is there a limit to how much Advertising we can tolerate? More importantly, is there a limit to how much businesses can spend on google ads?

There is a defined trend that is also supported by intuition and real-life evidence. First off, it is clear that the effectiveness of search ads and banner ads is decreasing. People are becoming increasingly aware of them and avoiding them, either unconsciously or actively through adblockers. On top of adblockers, businesses that use these forms of ads based on clicks or impressions also face the risk of fraud through bots and other “hacks”. Lastly, it is obvious that the most popular forms of advertising now is coming from influencers and other types of affiliate marketing. Google Ads can only go so far, and nowadays consumers are demanding a more personalized and “immersive” advertising experience.

Where’s the growth?

Google is actively pursuing other avenues to replace its falling ad revenue growth. In this section, I’d like to cover some of the most significant growth initiatives that the company is pursuing. These include Google Cloud, Youtube, and Waymo.

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Google Cloud

It’s all about the cloud these days, and Google has undoubtedly taken a piece of the pie. After Amazon.com (AMZN) and Microsoft, Corp. (MSFT), Google is the largest cloud provider in the world. We cannot deny that Google Cloud has actually been outgrowing its competitors, managing to gain market share. But with the segment still, as far as I see, there are no qualitative advantages to Google’s cloud offerings as of right now. Google Cloud cannot compete in size with AWS and Microsoft’s Azure has the dominant position in terms of quality and public cloud. I am bullish on Microsoft’s Azure and believe that it may become the dominant Cloud provider in the next few years. However, I cannot see Google taking much market share from Amazon or Microsoft, which means cloud revenues will also taper off. Even if cloud continued to grow at double digits it would still take a few years at the very least for it to even come close to representing a significant amount of Google’s revenues. While Google is doing the right thing and will benefit from the cloud, they have too little market share and were too late in entering the market.

Youtube

Another holy grail of growth is that of Youtube and Youtube TV. Granted, once again, we have seen significant growth in revenues in the last year, but there are some inherent problems with Youtube as a whole. Firstly, as is already stated in the Annual Report, cost-per-clicks remain low. On top of that, the platform as a whole is facing an exodus of creators as percentages of revenue split for creators have been decreasing substantially. Of course, the platform remains a great way to gain traction as a content creator, but anyone seriously contemplating it as a business or job will have strong incentives to move viewers to their site or platform. For users as well, back in the day YouTube’s primary benefit was the fact that it was ad-free, and with ads now playing even during videos, the platform has no real edge other than its scale.

Lastly, I’d like to mention Youtube TV, which is included under “Other” in Google’s reports together with revenues from Google Play. Just recently, Youtube decided to raise the price of Youtube TV by 30%. What Google is doing with Youtube TV is symptomatic of what is arguably happening with the whole business. Google used to offer superior and free products, and now that it has the size and trust of its clients, it is squeezing them as much as possible. Fair play to them, making money should be a priority, but there is only so much that people will allow or endure. After all, what does Youtube offer that can’t already be found on cable or Netflix?

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Waymo

Although autonomous driving still feels like it belongs in sci-fi movies, we know that behind the scenes, many companies are working tirelessly to deliver a technology that will save millions of dollars and lives. And here Google has a chance to be perhaps the first company to start commercializing autonomous vehicles. With Waymo already offering this service to a select user base, we could see a larger scale launch take place as early as 2021. But even if Waymo succeeds, it might still fall short. Michael McGrath estimates that Waymo could earn Google up to $40 billion by 2025. That’s about 25% of Google’s revenues today. Furthermore, he estimates that by 2030 the ARS market could grow to up to $700 billion, of which google could have anywhere from 20-30% market share. Indeed, if this is the case, investing in Google makes much more sense. But we must bear in mind Google also faces very hard competition, especially in my opinion from Tesla Inc (TSLA). Elon Musk has recently claimed to be on the verge of achieving level 5 autonomous driving. Of course, the CEO of Tesla is known for being overly optimistic about timelines, but there is a real chance here that Tesla could beat out Waymo.

Valuation

Over the last decade, Google has consistently achieved a >20% revenue CAGR year after year, which is what investors have come to expect. But with its main source of revenue being ads, what if Google only delivers good growth instead of amazing growth in the next 20 years? The point is that Google will have to reinvent itself to maintain growth rates high and investors happy. Don’t get me wrong. I am simply trying to point out that, given Google’s current business model, it will have to adapt to continue to be a top company as it is today. Waymo could be the thing that does this for Google, as an example along with its Other Bets, so this is where I will be looking. But in the meantime, don’t be surprised if growth begins to dwindle.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.

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