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Google's Moat - $10 Billion Won't Cut It, Warren...

September 10, 2012 | About:
The Science of Hitting

The Science of Hitting

236 followers
Charlie Munger and Warren Buffett are famous for their avoidance of the tech industry, largely because of the rapid pace of change and the general lack of sustainable moats (look at HTC over the past decade to see how rapidly this change can be, or at Nokia (NOK) to see how quick a “moat” can disappear). However, despite their tech aversion, Charlie made some interesting comments at the 2009 Berkshire Hathaway (BRK.B) annual meeting in regards to Google (GOOG): "Google has a huge new moat. In fact I've probably never seen such a wide moat."

These comments by Charlie are certainly worth some thought, particularly in the context of something Warren said years ago about Coca-Cola (KO): “I say to myself, give me a billion dollars and how much can I hurt the guy? Give me $10 billion dollars and how much can I hurt Coca-Cola around the world? I can’t do it. Those are good businesses.”

Google’s dominance in search, and what would be needed to supplant that leadership, can be studied thanks to Microsoft’s (MSFT) entrance into the industry with the announcement and worldwide launch of the Bing search in June 2009. The question is simple: Can a company with boatloads of cash ($31 billion when the search engine was launched) supplant one of the widest moats in the world?

Looking back at Microsoft’s financials, we can see a clear breakout in fiscal 2007, when the company lost $732 million in the online services business (OSB) compared to a loss of just $74 million in fiscal 2006 and operating income of $402 million in fiscal 2005; in the explanation from the 10-K, the company attributes the loss largely to “increased headcount-related costs as a result of continued search and advertising platform investments.”

Teasing out what portion of OSB is directly attributable to Bing is all but impossible, but looking at OSB as a whole shows the increase in investment behind the segment leading up to the launch (Microsoft’s fiscal year ends June 30, so Fiscal 2009 covers the results/expenditures through the first month of the search engines existence, when Microsoft commanded roughly 8.5% of U.S. searches); here’s the operating loss by the segment per year:

Fiscal 2007 ($732M)
Fiscal 2008 ($1.22B)
Fiscal 2009 ($2.25B)
Three Year Total ($4.2 billion)


What has happened since then? Microsoft has continued to pour money into the service, and has targeted the brand with hopes of building some equity among the average consumer (considering that when most people need to find something on the internet they “google it,” Microsoft has a long way to go with building mind share). More recently, the company has focused on blind comparisons between the two products (similar to the Pepsi (PEP) Challenge, which started in the 1975), with the claim that testers on average prefer Bing results 2:1 over Google. As expected, advertising and promotional events, along with continued product development, investments in data center & equipment, etc., can be expensive; in the three fiscal years since product launch, the online service division has reported the following figures (with Fiscal 2012 excluding the impact of the non-cash charge for aQuantive):

Fiscal 2010 ($2.41B)
Fiscal 2011 ($2.66B)
Fiscal 2012 ($1.92B)
Three Year Total ($7.0 billion)


As we can see, the online services division (again, to stress this point – this is simply a proxy for Bing, since I cannot breakout the revenue/expenses by individual product in the segment) has collectively lost more than $11 billion since initial investment in the search engine began; for all this spend, Microsoft’s organic share in the domestic market is just 15% - compared to roughly two-thirds of the market for the 800 pound gorilla in the room, down slightly from an estimated 70% share in the U.S. at Bing’s inception.

The fact that Microsoft, after spending billions of dollars, has only made a small dent on the market to date, is truly astounding: Remember, we’re talking about a product that the majority of consumers consider more attractive during blind tests (at least according to MSFT), that offers a tangible benefit over the competition (essentially paid to search via Bing Rewards), and could switch to with the simple click of a mouse. It appears that Charlie may have been right to say that he’s never seen such a wide moat – because even the market clout of Microsoft and more than $10 billion has done little to unseat the dominance of Google in U.S. search.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.4/5 (36 votes)

Comments

vchaser
Vchaser - 2 years ago
Good article! In fact MSFT paid people to switch to Bing and that strategy did not work. I still remember some years ago MSFT paid you fat cash when you used Bing to search and buy some stuff online. But that plainly did not work. MSFT now holds around 15% of search Market share in US, and it owes a big THANKS to YHOO giving up its search muscle.

Android can make the Google moat much wider, and time can tell it work or not. However, Google also has its weak points.

The Science of Hitting
The Science of Hitting premium member - 2 years ago
Vchaser,

Thanks! And they still do - Bing Rewards offers gift cards and other items simply for using Bing to search (I've earned roughly $50 in Amazon gift cards in the past couple of months); it's simply amazing to think that Google has such commanding mind share over the competition...
Matt Tommasiello
Matt Tommasiello - 2 years ago
Vchaser,

I'm curious to hear your thoughts on their weak spots.

Thanks,

Matt
motivator
Motivator - 2 years ago
What good is an impregnable moat when that moat does little or nothing for the investor? One of the main things that Munger, and Buffett for that matter, looks for isn't an impressive moat. It's wether management is looking out for shareholder interests. This company is CLEARLY using share holders as patsies. You give them money and now you don't even get a representational vote!
swnyc2
Swnyc2 - 2 years ago
Science,

Another nice article... as usual!

You nicely demonstrate the value of a strong moat. I think your assumptions about OSB are fair, although I'd argue MSFT's search business share is currently closer to 30%, given they have teamed up with YHOO.

It's interesting to note that once MSFT developed their own moats (e.g. Windows and Office), they seemingly have dedicated themselves to attacking the moats of other companies.

Most long term MSFT shareholders probably wish MSFT had never gotten into the search business. I'm sure they would have done better if the cash had instead been returned to them in the form of dividends, which they could have invested in other stocks -- including internet search stocks, like GOOG for example.

However, now that so much cash has been sunk, it's interesting to speculate as to what MSFT should do. OSB is losing lots of money and will continue to do so for the forseeable future. If MSFT were to spin off or just close down OSB, I think MSFT's stock price would likely rise. Yet, in every private industry I can think of, there is always room for at least two profitable major players. Is search fundamentally different? I wonder if OSB will ever turn a profit for MSFT?

Rather than give up, MSFT appears to be doubling down by attacking the moats of iOs and Android in its attempt to build a 3rd ecosystem with WP8. If they are successful in that regard, I could see them increasing their mobile search share substantially, whether this will help lead to a profit for OSB, I'm not so sure. Things certainly don't look good to date. Nokia has been very unsuccessful with their windows phone products, even with substantial investment from MSFT.

Of course, the tide could change. MSFT was successful in attacking the video game moat with their X-box product. Perhaps they will eventually prevail. However, I think it's likely that when all the smoke clears, MSFT management would have better served shareholders by returning cash to shareholders rather than fighting all these moats!
w1omega
W1omega - 2 years ago
After watching Steve Jobs video on Youtube and thinking about my own smartphone usage patterns, I realized I use apps like Yelp a lot more than I ever search. Both Facebook and google have been concentrating on cellphone usage to capture that market, which I assume will become more and more important. You should think about that especially since tablets like ipads are on the rise.

I had my share of technology stocks becoming obsolete. I recently purchased GLW (Corning, which makes gorilla glass for some ipads and smartphones), but couldn't figure out if the New Ipad is using GLW's stuff or not, so I sold after owning for less than a week.

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