Alphabet

Extract from Portfolio Manager Commentaries – Sept 2022

Alphabet has many ubiquitous, critical services that people use daily and which simplifies their lives. Most people use Google, Alphabet’s largest product by revenue and profit, daily, and even unconsciously, to complete tasks. Businesses use it to attract customers. Including search, Google now has nine consumer products with over 1 billion users* and a large and fast-growing enterprise business, called Google Cloud Platform (GCP).

The core search business, Google, remains very strong and the company continues to deliver valuable innovation in this segment. In Q2-22, search revenue grew at 13.5%; however, if one looks at the growth rate since 2019 (to account for the spike in usage during the pandemic), search revenue grew at 20% per annum, faster than it was growing pre-pandemic. Alphabet has been innovating significantly in retail and travel. Retail is Google’s largest search category currently. Sundar Pichai, Alphabet’s CEO, mentioned that two-thirds of search users begin their shopping journey online, regardless of whether they make the final purchase online or in-store. They are working on ways to make the online shopping experience richer by, for example, adding more visual content, and more information and reviews for products as well as services. Underlying this is their artificial-intelligence driven shopping graph which now links to 24 billion product listings. Complex technology sits behind Google Lens, which allows users to take a picture of any product (or other item in the world) to learn more about it. This is effectively visual search and is a fantastic user experience with many use-cases.

Within travel, Google is working hard to improve the experience for consumers, merchants, and service providers. They have increased participation of hotels, as opposed to online travel agencies, in travel search results. Google copied its successful retail playbook by allowing free listings and bookings within search results and maps. Google has also made it easier for merchants to update rates and availability, to target consumers with offers and is improving its reporting to merchants. Richer listings help offset the strong position of Booking.com and Expedia, lead to higher conversion of clicks to bookings and, ultimately, better pricing for Alphabet.

Engagement on YouTube remains strong despite the rise of TikTok. YouTube has launched YouTube shorts, a short-form video-based service to benefit from the growth of this format. YouTube Shorts already claims 1.5bn monthly active users, a good feat in a small space of time.

GCP is another Alphabet business we are keenly monitoring. Google’s cloud is the third-largest cloud provider globally, with revenue of $19bn last year. It competes with two other behemoths in the space, Amazon (Amazon Web Services had revenue of $62bn in 2021) and Microsoft (Microsoft Azure revenue of $45bn). GCP’s revenue grew at 35% in Q3-22 and the business is close to break-even.

Alphabet recently acquired Mandiant, one of the leading cybersecurity companies globally outside of CrowdStrike and Microsoft’s security offerings. Cybersecurity has become a critical service for enterprises, given the proliferation of user endpoints (mobiles, tablets, laptop usage at home), which has become much more common since the pandemic. This will support Google Cloud’s enterprise sales strategy which is spearheaded by Thomas Kurian (an ex-Oracle Sales Head) who has done a commendable job at developing Google’s enterprise sales capability.

The current market dislocation has resulted in Alphabet trading at 17 times earnings if one excludes the net cash on its balance sheet (10% of the market cap). We commend management for spending all free cash flow on buybacks in the first half of the year.