The general rule of thumb not only in the stock market but in life is to “never say never.” Yet Alphabet Inc. (NASDAQ: GOOG) buying Snap Inc. (NYSE: SNAP) is now a distinct possibility. If it happens, it could actually mean even bigger things for GOOG stock.
Snap’s stock is suffering poorly on the stock market. Since late-September, selling volume accelerated, pulling the stock to yearly lows. At a recent close of around $7.00, will GOOG sniff around and buy the hip, wildly successful video chat app?
Google is probably noticing the very steep discount on Snap stock, at least relative to what it was willing to pay a few years back. Prior to Snap’s IPO, Google was reportedly willing to pay $30 billion. Today, Snap’s stock trades a market capitalization of $9.6 billion.
Alphabet’s Google does not need Snap to grow because its core business is doing so well. The firm reported earnings of an incredible $11.75 a share as revenue soared to $32.66 billion, up 25.6 percent from last year, in the second quarter alone.
To characterize this growth as substantial is understating Google’s strength. Sites continued to show year-on-year momentum. Innovation and secular growth, led primarily with mobile search, contributed to the strength. AdMob and programmatic advertising are also positive factors for the company’s growth.
Revenue by Geography
Revenue from the U.S. rose 21 percent Y/Y to $14.9 billion. EMEA revenue topped 10.8 percent, growing 26 percent. TAC and total cost of revenue rose 34 percent to $13.9 billion.
Still, GOOG investors did not concern themselves with the higher costs. Content acquisition costs, primarily for YouTube, added the most to the higher costs.
Google spent $10.9 billion in the quarter with R&D making up most of the costs. Unfortunately, the EC fine led to operating expenses of $16 billion. Though that ~ $5 billion additional cost is one-time, it added no value to the company and was an unnecessary expense it had to pay to Europe.
Google Is a One-Trick Pony and That’s Okay
The tiny $145 million in revenue in the Other Bets category shows just how concentrated the search business is in advertising. Fiber and Verily were the only major contributors on this line of business.
Google did not make money here as operating losses topped $732 million. Even though the numbers were in the red, management still expressed praise for the unit.
Waymo expanded its partnership with Fiat Chrysler. Google parent Alphabet announced that Loon and Wing would become independent companies under Alphabet. And as long as the advertising business enjoys strong momentum, Alphabet need not worry about losses in the Other Bets unit.
Growth Opportunities
Artificial Intelligence is clearly a growth area for Google. Its Google News app uses AI, or machine learning, to highlight top stories and to organize it for end-users. The more suitable the content presented to users, the more likely the user spends more time on the app.
Google Assistant, which competes with Amazon.com’s (NASDAQ: AMZN) Alexa, also employs Google’s machine learning. By the end of 2018, the app will be available in over 30 languages in 80 countries.
That global reach will most likely drive adoption for the app. Its popularity will only grow as Assistant connects to dryers, refrigerators, doorbells, and 5,000 other devices in the home.
Limitations to Growth
Google’s decision not to enter the Chinese market shuts the company out of one of the biggest growth opportunities. Even though adhering to the company’s morals may not pay off financially, it was still the right thing to do.
China is widely known to contravene the widely accepted principles of human rights. Building a search algorithm that easily identifies citizens who are likely to protest against the government compromises the company’s beliefs.
Valuation
Per Tipranks, the average price target is $1,389, or upside of around 15 percent, based on 33 analysts. If instead, investors applied a 5Y DCF Growth or Revenue Exit Model, the stock’s fair value could be higher. This assumes that revenue grows in the double digits for the next five years.
Your Takeaway on GOOG Stock
Even though Google seems unlikely to buy Snap, given the video chat company’s financial troubles, Snap may need to consider a friendly offer.
From Google’s point of view, it already has Hangouts, Dialer, and Gmail, so adding Snap to the family of apps would seem to make little sense. Despite the lack of synergy, Snap is on sale and is still a hot app that appeals to young users in North America.
If Snap becomes a unit of the search giant, it would have additional funding that it needs to strengthen the app. In time, Snap will make a profit Google shareholders will be happy with the acquisition. This is especially true when Google could get Snap Inc. for almost $20 billion cheaper than what it was offering before.
The author does not hold shares in any of the companies mentioned.
