Alphabet’s (GOOG, Financial)(GOOGL, Financial) revenue grew 18.3% in 2019, to $162 billion. The primary drivers of Alphabet’s remarkable growth were once again mobile search, YouTube and Google Cloud Services. In a first, Alphabet disclosed revenue figures for YouTube and Google Cloud in the company’s fiscal 2019 financial report. YouTube generated $15.1 billion in revenue in 2019, up 36% over 2018. Google Cloud generated $8.9 billion in 2019, a 53% improvement over 2018. Google Cloud’s growth looks set to continue; the company disclosed an order backlog of $11.4 billion.
Growth at such a rapid pace for a company of Alphabet’s scale is hard to comprehend and even harder to sustain. Search advertising revenue is Alphabet’s most mature business and its biggest economic engine by far, and it grew 15% year over year.That is nothing short of heroic for a twenty-year-old business segment generating roughly $100 billion of annual revenue.
The rapid growth of younger business segments that remain in their investment phase has naturally pressured Alphabet’s operating margin over the past several years, causing revenue to outpace operating income. 2019 was no exception to this trend. We estimate Alphabet’s operating profit after taxes grew 13% in 2019, after certain adjustments that filter out noise in the reported figures.The wisdom of trading operating margin for revenue growth will be determined by the long-term return on Alphabet’s myriad current investments, and for many of these it will be years before the results are in. Google Cloud in particular will require significant investment as Google battles Amazon Web Services (“AWS”) and Microsoft Azure for its share of the cloud computing services market. It is worth noting that AWS achieved an operating margin nearly equal to Alphabet’s current operating margin when it was about the size of the current Google Cloud business. We are hopeful that Google Cloud will generate a healthy and expanding margin as the size of the business increases.
In the fourth quarter, Alphabet announced that founders Larry Page and Sergey Brin would step back from their respective roles as Alphabet’s CEO and President. Sundar Pichai, already CEO of Google, Alphabet’s most important business, will take over as CEO of parent company Alphabet and assume responsibility for the company’s Other Bets in addition to his previous responsibilities. It will be interesting to see how Alphabet’s “moonshot” projects, collected under the banner of Other Bets, will develop under Pichai’s leadership. While Alphabet’s many non-advertising initiatives help the company attract and retain talent, and a few of them have the potential to grow into sizeable businesses in the long term, we believe there is scope to improve Alphabet’s focus when it comes to the allocation of resources to Other Bets.
This coming June will mark the ten-year anniversary of our investment in Alphabet. As we write this, the investment has returned 20% annually, a remarkable result given that Alphabet enjoyed a market capitalization exceeding $150 billion at the time of our investment.This record is a credit to the company and a testament to the remarkable power of Alphabet’s business and that of dominant internet platforms generally. Our appreciation of the unusual ability of these platforms to generate durable growth at enormous scale has informed our subsequent investments in Amazon, Facebook and Wayfair, all of which are market leaders in their respective niches.
With great power comes great responsibility. It is clear that certain scaled internet-based platforms, including Alphabet’s YouTube video platform, possess the wherewithal to shape the cultural landscape in profound and often unpredictable ways.To monitor the body of user-generated content onYouTube requires an enormous investment in people and technology, and it is little wonder that YouTube and other social platforms prefer to be characterized as neutral distributors of third-party content rather than as publishers, given that the latter designation carries the implication of editorial control and its attendant obligations. Over time, cultural and political developments have rendered a laissez-faire approach to content distribution increasingly untenable, leadingYouTube and its peers to invest significant sums to improve the security and monitoring of their platforms. It is a certainty that billions of dollars of further investment will be required, but taming problematic content is a profoundly important goal from both a societal and a business standpoint. Progress in this area will make the dominant social platforms more sustainable, more trusted, and harder to disrupt.
In light of the substantial increase in the company’s valuation in 2019, we modestly reduced the size of our Alphabet position. However, Alphabet remains a compelling business with an attractive valuation, and it remains the largest position in the Sequoia portfolio.
From Ruane Cunniff (Trades, Portfolio)'s Sequoia Fund mangement performance discussion for 2019.
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