Alphabet – Dominating the Global Search Engine Space

James Buckley

26.05.2023

Alphabet – Dominating the Global Search Engine Space

Alphabet, which launched in 2015, is the holding company for Google, the world’s dominant internet search engine. Alphabet is divided into two main divisions; Google Services and Google Cloud. Google Services provides some 90% of group revenues and, as well as the search engine, includes Android the leading mobile phone operating system; YouTube, the world’s most popular video-sharing site as well as Google Maps; Chrome and many other Google-branded internet services.

 

Google Services derives its revenue predominantly from advertising on its search engine and YouTube and other Google platforms, benefitting directly from the rapid growth in e-commerce and Google’s unparalleled ability to drive consumers to its advertisers’ e-commerce sites.

 

Google Cloud is a fairly distant number three behind Amazon (AWS) and Microsoft (Azure) in the provision of cloud computing services, however, it is enjoying rapid growth in this attractive segment.

 

Alphabet has another smaller loss-making division, Other Bets, mainly consisting of early-stage technology companies, including Waymo, the autonomous ride-hailing service currently operational in Arizona. Alphabet has been active on the M&A front and in March 2022 acquired cybersecurity firm, Mandiant, for $5.4bn in an agreed cash offer.

 

Cybersecurity is an increasingly critical technology industry sector, and Mandiant will be integrated into Google Cloud. In early 2021 Google completed the $2.1bn acquisition of wearable technology maker, Fitbit. Like other technology giants, Alphabet has emerged from the Covid pandemic in a stronger financial and competitive position, as secular trends towards digitisation, e-commerce and remote working all benefit its two main divisions.

 

Whilst not immune from the impact of any deterioration in the macroeconomic climate, Alphabet’s positioning in these long-term growth areas and strong balance sheet, which will facilitate continued investment in the field of Artificial Intelligence (AI), represent an attractive investment proposition, especially post the significant 2022 share price correction.

 

Alphabet reported Q1 results after the market close on 2nd May. Revenues were $69.8bn, up 3% over Q1 2022, (+6% in constant currencies), and ahead of expectations of $68.7bn, whilst EPS of $1.17 were down from $1.23 a year ago, reflecting $2.6bn costs associated with mass lay-offs as Alphabet puts greater emphasis on operational efficiency, but ahead of forecasts of $1.08. This reduced operating margins from 30% to 25%.

 

Google Search revenues rose 2% to $40.3bn ahead of estimate of $39.4bn, whilst ad revenues from YouTube were down 3% to $6.7bn, marginally ahead of expectations. Total group ad revenues were virtually unchanged year-on-year at $54.5bn, whereas a slight decline had been expected. Revenues from Google Cloud jumped 28% to $7.5bn, in line with forecasts, and announced a profit for the first time of $191m.

 

Alphabet also announced a $70bn buyback this year, in line with 2022, although at the current lower share price this represents an increased 5% of existing share capital being retired. In the post-results conference call, Alphabet stated it had made “good progress” in A.I. and would continue to exercise tight cost control elsewhere in the business, whilst there were signs of stabilisation in the ad business. The shares were marked modestly higher post these better-than-expected results in after-hours trading.

 

Despite gaining 40% year-to-date, Alphabet shares are down around 15% from their high in Q2 2021, reflecting weakness in the broader technology sector, which has been impacted by rising bond yields and fears of recession. Recent weakness in the US dollar, reversing the trend of recent years, could also act as a tailwind for earnings.

 

Digital commerce penetration in the US is currently just under 20% leaving plenty of future growth for Alphabet in this channel. Cloud computing is also an industry with attractive growth fundamentals and Google Cloud can continue to make modest inroads into gaining market share here which should lead to sustained profitability by 2024.

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