Hedge fund manager Michael Burry, founder of Scion Asset Management, of "The Big Short" fame now holds Alphabet (GOOG, Financial)(GOOGL, Financial) as his No. 2 investment.
Alphabet is a new investment for him and the only stock in his concentrated portfolio I own as well and have written about on GuruFocus. Earlier this year I highlighted another Burry pick –Â Nexpoint Residential (NXRT, Financial)Â –Â and it went on to do well:
At this point Alphabet’s revenue is mostly coming in through advertising. Close to 90% of Google's revenue is tied to Google sites and Google Network Member sites. Google shows users ads on its own sites (like Google.com and Gmail) but also shows ads on network member sites. Everything else is noise, really as exciting as self-driving cars sound.
We can’t be sure what the exact reason for Burry’s interest is, but we do know his penchant for deep research into areas few others understand. My best guess it is one of two main reasons that drive his interest:
- Potential of Google’s cloud business.
- Google’s competitive advantage.
Google’s cloud business
The potential of Google’s cloud business is something that has captured my attention for most of the year. I expected the cloud story to play out more prominently this year. The company acquired Diane Green’s previous company Bebop with the specific purpose of her heading its cloud business.
I expect the cloud market will turn into an oligopoly over time. The public cloud depends on security which requires dedicated departments with highly specialized personnel that are expensive to keep on the payroll. Worse, these departments are likely to get cut in times of distress, and it will take just one or two corporate catastrophes before lots of companies will get out of trying to do cloud in house.
Tech companies who already have infrastructure at scale and and need to migrate server capacity around the world are well positioned to offer cloud services built off the needs of their legacy businesses. Both Alphabet's and Amazon's (AMZN, Financial) infrastructure are natural matches and position them well to take a spot in the future oligopolistic market.
According to Urs Hölzle, who has been Google's infrastructure man since pretty much day one, author of The Datacenter as a Computer, Alphabet wants to surpass advertising revenue by cloud revenue as soon as 2020! I’m at a lack for metaphors just how bold that statement really is. Basically Google needed to create $80 billion of sales out of virtually zero, when he made the call, in just a few years. Although Amazon is currently the leader with Amazon Web Services, it's also estimated that 99% of the market hasn’t been served yet.
Google CEO Sundar Pichai is also bullish on the cloud efforts and some key quotes from him on the subject can be found in an earnings call earlier this year.
Businesses now see that the easiest-to-use, most price-effective and secure infrastructure can best be obtained through the major public cloud providers. Alphabet cloud platform is already used by more than 4 million applications. And we recently introduced a new way to purchase and use virtual machines called Custom Machine Types so that clients can tailor their purchases based on the memory they need to get the best possible cost and performance.
Google’s competitive advantage
Google’s competitive advantage is based on its market share. The company holds a dominating 60% market share while having no presence at all in China after having pulled out of the country. In my prior article on Google I explained in depth why market share is crucial given current search tech:
Search quality becomes much better if you have extensive knowledge of the searcher. This is one of the reasons people often name Facebook (FB) as a possible challenger to Google. Sure Facebook also has extensive knowledge of you, enough to serve you solid contextual ads. However, the most important thing to know about someone to improve the quality of his or her search results is his or her search history. Google is collecting the valuable search history on 60% of all search users. With every search switching costs become higher for its users and Google's service to them becomes better. If you don't immediately grasp how valuable your search history is, think of how helpful it is to know that someone studied at NYU and compare that to when presented with 10 links on previous searches for "NBA Tonight" knowing which links he or she ended up selecting. Which data is most helpful the next time this person is pulling up data on upcoming NBA matches?
Because Google is collecting the absolute most important context to provide a good search experience; search history on 60% of all human beings with access to an Internet connection (while making the conscious choice to stay out of China). It will be extremely hard to match the quality of search Google provides by a new incumbent.
The longer Google dominates the search market, the greater its competitive advantage becomes. With every search its competitive advantage is strengthened. For Google to get disrupted the new search technology needs to bridge an ever wider advantage. Challengers really need to try and find a strategy that works 100x better because with an incremental strategy it will be next to impossible to displace Google. Possibly Burry understands this and loaded up on Google to take advantage of its competitive position for years to come.
Disclosure: Long Alphabet.
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