Alpha-Bet

 

Betting on Alphabet

I reinstated a mid conviction position into Alphabet C stock on 21/09 as the Nasdaq corrected from its previous lofty valuations. Key Thesis of Alphabet is that it will be a continual compounder and continue to generate sufficient advertising revenue from its proprietary search engine and Youtube ads, and generate future lumpy returns from its Alpha-bets. My revised understanding is that the long term compounding thesis is not affected and it is able to continually develop its innovative product catalogue. The slight margin of safety compensates for the risky nature of the company. Because the company is so difficult to value due to its <Call Option> nature, the best way to invest in Alphabet is to treat it as a charitable contribution and not be emotionally affected by its hits and misses, and let the geniuses in google run the company uninterrupted.

A key reminder to myself as I mature as an investor, is to not view Tech companies as a blob and use standardized metrics (P/E, Near term earnings, revenue growth), but rather observe which industry it is positioned to understand the inherent profit margins as well as the scalability of the business. (Capital intensive nature of Tesla and Nikola, upfront development cost of content creation of Disney / Netflix, intense competition in the smartphone space etc). 

Eric Schmidt (interview below) gave lots of valuable pointers on the story of google, how Google was a series of accidental creations that was structured from sound and rational engineering, data driven decision making, and flexible rules based principles. This forced me to rethink what can be considered a great tech company (Great product then scalability) in the fast moving technology space.

What I like about the company
Temporary headwind in digital spend will not affect long term outlook
Total addressable digital ad market is still huge and growing with huge potential in the emerging markets. Possible decline in ad spending is temporary as companies eventually have to advertise to promote brand awareness and product visibility. Smartphones and computers are a permanent feature and there is no good substitute or sufficiently strong competitor in the search engine and you-tube business. 

Product focused management and raw talent base
Portfolio of Alpha-bets (Call options) handpicked by the top technical visionaries of the tech industry (Larry page, Sergey Brin). Data-driven and rational culture in management and product development, talent recruitment and company culture / policy. (Structured by Eric Schmidt) . Product focused CEO Sundar Pachai will continue to develop google's portfolio of great products and eventually monetize them.

Berkshire influenced corporate and financing structure
Decentralized Corporate structure (inspired by Berkshire) will encourage innovation and prevent bureaucratic behavior to set in, and cash heavy capital structure allows it to opportunistically make acquisitions or develop its emerging bets. 

 

Operational leverage inherent in the business
Limited upfront cost in infrastructure, No cost incurred in content creation and unlimited re-usability of others content.

First move advantage in Youtube allows it to create a portfolio of reusable assets with virtually no content creation cost (compared to Netflix). Upfront fixed costs to host servers and data centers but virtually no incremental cost to recycle content and increase its video assets. Ditto for the search engine content which catalogues information, and blogger / content creation. Huge portfolio of content can be infinitely recycled with unlimited use with minimal manpower input due to its machine learning algo -driven suggestions.

Network Externalities in hardware and software to keep users enclosed and generate superior user insights, and superior distribution network
As google entrenches its users in its ecosystem, it has a huge and sticky user base and able to collect user information to design new products, and immediately distribute new products / services once they are deemed successful in HQ. There is literally no cost and no limitation to immediate and infinite scaling of the usage of its products once they are released and become viral.

Network externalities continually improving and adapting statistically driven Google Search algorithm

ExCeo Eric Schmidt on how Alphabet is created and structured

CFO Ruth Porat on capital allocation and balance sheet

Key risks about the company
Because I like the company so much and is so entrenched in the ecosystem, it is difficult to objective value the company and I will inevitably suffer from unconscious bias. My approach is to seek a bear thesis from a investment forum, and whether it can hold up despite possible decline in the digital ad spend market.

Restrained monetisation/ Hard to monetise portfolio of successful products?
Google has a huge portfolio of strategic assets like Gmail, Google Maps, Youtube, Search, ChromeOS, Andriod OS, Google play store. A quick look at the tracker on my phone noted an impressive amount of time spent on the ecosystem that was offered to everyone for free. Although the freemium-for-data business has worked so far, no one can guarantee whether these services will be expected to be FOC forever if no one is ever willing to pay for it.

Slowing rate of revenue and profit growth
As alphabet approach Mega-cap status, it is hard to assess whether it can continue to generate its massive growth per the past. Investors can punish the stock hard and create a rapid decline in earnings multiple if short term revenue / earnings are missed. Google is NOT for the faint hear-ted.

Possible inability to fund new(er) sources of revenue beyond current core business
The slowdown of digital ad spending could hit the revenue of Alphabet hard considering its diversified portfolio assets but concentrated ad revenue stream. Baidu's fall from the BAT is a sombre reminder that search ad revenue may not stay as strong forever. As digital ad business becomes increasingly congested, the other Alphabets may all be a flop and no one can reasonably predict the future. There will likely be continually more products ending in Google Graveyard, and only a few bets will hopefully massively succeed.