My core concern towards Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) stock has been its reliance on its advertising business. AdSense, YouTube and other advertising revenue streams comprise a great business, to be sure. They provide a solid moat for Alphabet, and a strong profit base for GOOGL stock. But there are challenges, most notably the shift to mobile that continues to compress CPC (cost-per-click) rates — and potentially, profit margins.
That concern looks increasingly overblown, as GOOGL stock followed Amazon.com, Inc. (NASDAQ:AMZN) in trading over $1,000 per share for a while. What looks like a developing online advertising duopoly between Alphabet Inc and Facebook Inc (NASDAQ:FB) mitigates those risks. But optimism toward Google’s “Other Bets” — what the company once called ‘moonshots’ — also benefits GOOGL stock.
That optimism has some basis. Alphabet has a number of intriguing initiatives underway, most notably its Waymo self-driving car unit.
And there’s another way to look at those businesses: even if they fail, there’s a benefit to GOOGL stock. The Other Bets businesses are losing money — about $3.6 billion in 2016, per the Alphabet Inc 10-K. If they work, they provide value. If they don’t, Alphabet Inc can kill the projects — and improve margins.
With GOOGL stock soaring, it sure looks like investors are pricing in some level of success. From here, that looks a bit optimistic. But, admittedly, Alphabet Inc does have a few real drivers outside its core business. And that optimism could keep GOOGL stock in the four figures for some time to come — if not permanently.
Waymo and GOOGL Stock
In December, Alphabet Inc spun out its self-driving car unit into a standalone company: Waymo. That unit has received the most coverage of Alphabet moonshots, in part because of a nasty, public lawsuit with Uber over intellectual property.
But hopes are high for Waymo. The company already has sent a self-driving car through the streets of Austin, Texas. While Waymo won’t manufacture cars, it is partnering with Fiat Chrysler Automobiles NV (NYSE:FCAU) in its efforts.
Competition will be fierce, of course. Tesla Inc (NASDAQ:TSLA) is looking to dominate the autonomous driving space. Apple Inc. (NASDAQ:AAPL) reportedly has invested in its own efforts. Ford Motor Company (NYSE:F) replaced its CEO in a move seen as an attempt to focus more strongly on electric vehicles and, possibly, self-driving cars.
But Alphabet’s impressive AI and machine learning capabilities and head start might make it the favorite in the space. Morgan Stanley has estimated that Waymo could be worth $70 billion should Alphabet Inc decide to spin it off. That figure compares with a current valuation of Tesla of just $60 billion. And that sentiment could explain some of the recent optimism toward GOOGL stock.
Other Alphabet Inc Moonshots
While Waymo gets the most attention, it’s not the only potential mover in the Other Bets group. Alphabet Inc acquired Nest for $3.2 billion in 2014. In its 2016 10-K the company wrote that Nest products “remain top sellers” and attributed most of the segment’s revenue increase to those products. With the Internet of Things (IoT) an apparently major opportunity, and Alphabet Inc generally a successful acquirer (see YouTube and Android), Nest could be worth as much as $5 billion on its own at the moment.
Life sciences division Verily received an $800 million investment earlier this year for an unspecified “minority stake.” That would imply a $3 billion-$5 billion valuation, at least, assuming a 15%-25% stake was sold.
And CapitalG — formerly known as Google Capital — has a series of investments across the tech space. Those investments appear to be carried at around $6 billion — but that likely understates their value. Per the 10-K, nearly half of those investments were carried at the cost method, which may not reflect current value.
Most notably — and ironically, given lawsuits — Alphabet Inc owns a large piece of Uber. That investment alone likely created about $3 billion in value. CapitalG also owns pieces of AirBnB, and publicly traded companies including Care.com Inc (NYSE:CRCM) and Snap Inc (NYSE:SNAP). Indeed, CapitalG looks like one of the more successful venture capital firms in all of Silicon Valley.
Do Other Bets Really Matter For GOOGL Stock?
There is real value to GOOGL stock in its “Other Bets” division. The question, however, is how much. In an optimistic scenario, one could ascribe the following valuations to various Alphabet Inc properties:
- Waymo: $70 billion
- CapitalG: $15 billion (2x+ carrying value)
- Nest: $5 billion
- Verily: $5 billion
- Google Fiber: $2 billion
- X, Calico, Access, and others: $3 billion
This admittedly back-of-the-envelope calculation suggests the businesses, combined, could be worth as much as $100 billion. That’s an impressive figure.
But the market cap of GOOGL stock is over $640 billion. Roughly 15% of that market cap comes from these efforts — in what seems like an optimistic scenario. Waymo could turn south. Nest has a long way to go. Google Fiber has been somewhat of a disappointment, though efforts are re-starting in Louisville.
Should any of the efforts fail, there is a secondary benefit for GOOGL stock. As noted above, Alphabet Inc could cut spending. One would assume that a good chunk of the $3.5 billion loss in “Other Bets” is coming from Waymo. Reversing that loss alone could add at least $3 to GOOGL’s EPS.
Still, the rise in GOOGL stock to $1,000 and beyond is coming mostly from the core advertising businesses, and I still see that as a risk. Between mobile hurting CPCs, the YouTube ad strike and competition from Facebook, in particular, there’s a risk of a slowdown in that core business. And while “moonshots” are helping the valuation of GOOGL stock, a close look shows they won’t be enough to keep the stock afloat if sentiment toward the legacy Google business changes.
As of this writing, Vince Martin has no positions in any securities mentioned.