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Originally Posted On: https://www.monexsecurities.com.au/insights/trading-ideas/google-strategy-and-their-mergers-acquisitions/

 

Google Strategy and their Mergers & Acquisitions (M&A)

The US tech sector fell sharply during the month of May after U.S. regulators announced they would pursue antitrust action against large technology companies. The big FAMGA, specifically Facebook (ticker: FB), Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN) shares dropped off the cliff. Additionaly, Alphabet (Google’s parent company) is still unable to rise out of the valley as investors continue to worry about the large size of fines that Alphabet will have to pay, and the enormous impact it will have on its operating income.

For the short-term, the fines will definitely affect Alphabet earnings income, but we think the chances of it being broken up into smaller business units are rather slim.  Barring any unforeseen circumstances, the fundamentals are steady and positioned for further long-term growth. This may be a good opportunity to acquire the stock at the current undervalue price.

Let’s take a closer look at Alphabet today.

Alphabet is the parent company of Google. Google contributed 99% of revenue to Alphabet, with 85% of the revenue coming from its online advertising business. Other revenue comes from Google Play, YouTube, the cloud computing business and consumer hardware such as Chrome books, Pixel and Google Home. 

Alphabet owns an experimental research arm called “Alphabet X”, which has invested into many start-ups aiming to support future growth.

Alphabet and its subsidiaries have invested in more than 270 companies in the last 20 years. Alphabet’s three main investing arms, GV (formerly known as Google Ventures), CapitalG, Gradient Ventures, and Google itself invested in 103 venture deals in 2017 alone. Now, Alphabet has prioritised AI, cloud computing services and auto driving as well as expanding into enormous countries with large populations, such as India and China.

AI, Deep Learning and Speech Recognition

Alphabet has placed AI as a top priority. Google started its own R&D strategy in AI from early 2010 and Alphabet has launched two funds, Gradient Ventures and the Google Assistant Investment Program, dedicated solely to AI. Google has been actively acquiring AI start-ups for the past few years.

The most remarkable achievement is the acquisition of AI start-up, DeepMind in 2014. The foundation product of DeepMind, AlphaGo, amazed the world by 4-1 victory to a 9-dan professional ranking in the board game “Go” in 2016. Besides that, AlphaGo has continued challenging human talent in other games too. In March, DeepMind announced that their new algorithm product can assess eye scans with high accuracy. DeepMind needs to go through formal clinical trials, before getting marketing approval from regulators.

Google also managed to acquire an Indian company named Halli Labs which focuses on deep learning and machine learning systems.

In November 2017, Google acquired Banter to develop the capabilities for natural language processing for Google Hangouts.

Compared to other FAMGA companies, Google has been spending heavily on its own R&D, and ranked 2nd place after Amazon in 2017 by capex spend.

With more investments in AI and speech recognition, Google is trying to catch up with Amazon’s Alexa and Apple’s Siri. Recently, Google Assistant has been improving. Amongst other things, customers can ask Google Home to play music, call for an Uber, or play podcasts.

Last year, Google acquired most of HTC’s smartphone design division in Taiwan. Through this acquisition, Google gained the smartphone R&D team in HTC as well as a presence in the devices infrastructure space for its future involvement in the Internet of Things (loT) market.

CBinsights estimates the digital assistant’s market to reach $12 billion by 2024, and the smart home devices market to tap into the $122 billion market by 2022.

Cloud Services

This April, Google released their multi-cloud platform Antos. Antos is different from AWS or Azure, it is a multi-cloud platform for multiple services aligned with application modernisation, cloud migration, hybrid cloud, and multi-cloud management. 

Last week, Google entered into a definitive agreement to acquire Looker for its cloud computing business. Looker is a unified platform for business intelligence, data applications, and embedded analytics. CEO of Looker said the company provides services for more than 1700 companies, including IBM, Amazon, WeWork, SONY and Spotify. Revenue last year exceeded 100 million dollars with 70% year-on-year growth. 

Google hasn’t reported specific revenue numbers for its cloud business yet, but on its 2017 Q4 earnings call, the company announced that its cloud business is now bringing in $1 billion per quarter.

According to Canalys data released this February, for 2018 Q4 cloud market share, Amazon Web Services (AWS) remained at 32.3% market share, whilst Microsoft Azure grew to 16.5% share from 13.7% in the same period last year, and Google Cloud only took 9.5% of the big pie, far behind the competitors. But Google Cloud is catching up faster than others as its annual growth hit 81.7%.

Google also announced it will integrate blockchain technology into its cloud platform, through a partnership with blockchain startups Digital Asset and BlockApps. Now through BigQuery Public Datasets program, customers can check datasets consisting of the blockchain transaction history for Bitcoin, Ethereum, Bitcoin Cash, Dash, Dogecoin, Ethereum Classic, Litecoin, and Zcash.

Cloud computing market is expected to reach $513 billion by 2022, and the cloud storage market is expected to reach $90 billion by 2022. As Google continues to focus their first priority in Cloud businesses, the company will tap more market share in this fast-growing space.

Quantum Computers

Quantum computing is such a difficult area that many scientists can’t explain well. It is not only about accelerating processor speed but also helps us build more complex models for financial risk management, chemistry experiment simulation, environment changing predictions, new medicine test stimulations, and the list goes on.  Quantum computing will play a big role in accelerating tasks for AI too.

Last March, Google announced their quantum computer, Bristlecone, which can run on a 72-qubit gate-based computer processor. This is much far larger than IBM’s 50-qubit processor, or Intel’s 49-qubit processor. Google released Cirq, an open source framework for researchers and developers to operate on the quantum computing program last July.

Although scientists admit that quantum computers will bring more innovation to our daily life, companies are still searching for commercial use applications. Google said they expect to launch their commercial quantum computer within 5 years.

Other Business

Besides high-end technology competition, Google is also trying to catch up with Amazon in e-commerce. Google expanded its same-day delivery e-commerce services together with Target, Costco, Fry’s Electronics and other retail shops in 2017. The biggest feature of this service is free same day delivery in selected areas. The subscription fee is lower than Amazon Prime too. We think Google will reinforce itself in the e-commerce business because of its advanced auto-driving technology.

Google’s self-driving car, Waymo surpasses others in the space. According to the Autonomous Vehicle Disengagement Reports 2018, reported by State of California Department of Motor Vehicles (DMV), Waymo was outstanding comparatively speaking. Waymo doubled the second place disengagement distance set by GM Cruise. It’s ironic that Uber was ranked last in all 48 companies that were in the report, with only 0.4 miles per disengagement. Apple was ranked second last, with 1.1 miles per disengagement.

This result also proved Google’s strong presence in the AI industry. Google is engaging in the delivery industry to compete with Amazon. Now Google holds almost the same number of patents with Amazon, related to the delivery industry. 

It is said the auto-driving market reached 4.82 billion dollars in 2018, and will grow to 7.03 billion dollars in 2021. As the leader in this industry, we think Waymo will bring more benefit to Alphabet both in revenue and in market integration.

Conclusion

From EU’s GDPR to DOJ’s antitrust action, Alphabet has lost $80 billion of its market capitalisation. Yes, for short-term this will have a major impact across the industry. But we can still see the potential for growth.

It’s clear the company is growing steadily both in revenues and operating income, and the operating margin remains at a high rate over 20%. 

Additionally, Alphabet ended 2018 with $109 billion in cash and securities, which provides enough room to increase shareholder returns.

At Hathaway’s annual shareholders meeting, Mr. Munger said, “I feel like a horse’s ass for not identifying Google. I think Warren feels the same way. We screwed up. We could see in our own operations how well Google advertising was working and we just sat there sucking our thumbs, so we are ashamed. We’re trying to atone.” Technology companies are not easy to predict and invest in, as many of us can’t really understand aspects of core technology and its application.

With the share price sitting just above recent lows, do you think this is a buying opportunity for Alphabet?

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