How Long Does Google Have to Make Its Other Bets Work?

Is Alphabet running out of time with its moonshots?

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Nov 23, 2016
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Alphabet’s (GOOG, Financial)(GOOGL, Financial) Other Bets segment has been a point of discussion for a long time. For many years, what the company called ‘moonshots’ have mostly remained true to their name. As Alphabet continues its march towards becoming the world’s largest company by market capitalization due to weakness in current leader Apple (AAPL, Financial), and helped by its own advertising revenues that have been growing by double digits, Alphabet’s continuing search for revenues outside its advertising realm remains a pipedream.

Traditional advertising still rules, giving digital more room to grow

Alphabet, Google’s parent company, is enjoying an extended period of growth despite counting its first $10 billion in 2006. Ten years later, with $75 billion in annual revenues and counting, Alphabet’s core sales are looking good for another 10 years. The era of digital advertising is far from being over. We have seen tremendous growth in the last 10 years, but despite that growth, digital advertising is yet to become the medium of choice for all advertisers as traditional mass advertising mediums still holding plenty of sway.

Take Netflix (NFLX, Financial) for example, the company once touted it would make cable companies obsolete and lead the charge in a shift towards an internet-based content delivery system. The company recently signed a deal with Comcast (CMCSA, Financial), allowing their product to become part of Comcast’s bundle. Comcast reaches millions of users, and with Netflix facing an increasingly competitive and highly penetrated U.S. market, the company was left with no choice but to align with one of its long-time rivals.

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The future is definitely digital, but that transformation might take years, if not decades, to become a reality. TV advertising seems to the biggest enemy for digital, as the growth for the latter in the past five years came at the cost of print media, which suffered horrible losses at the hands of digital advertising. Alphabet’s own revenues have been growing at strong double-digit rates while a much younger and smaller competitor, Facebook (FB, Financial), has been hitting above 50% top-line growth for the past several quarters. Clearly, when you have two companies earning in the billions and are still capable of growing at such rates, you know that market has enough room to grow in the medium term.

An analogy from Apple’s current situation

What Google will face down the road is very similar to the problem Apple is facing right now. From 2006 to 2014, Apple enjoyed strong growth as iPhone sales went from zero to above 200 million per year. But that was the period when the entire world was desperate for a smartphone, and only very few were able to get them.

As penetration grew within Apple’s target market, iPhone sales started to slow down. It is not a problem specific to Apple, but rather the entire smartphone industry. Their days of strong growth are over simply because penetration in developed markets has reached very high levels. It is now time for stable sales and incremental growth, no more.

Google’s window of opportunity

Google has not reached that stage yet, and probably won’t for the next five to 10 years. But if you turn that around and look at it in respect to Other Bets, Google has less than 10 years to show significant returns from this unit.

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Alphabet’s ad dollars are looking good for now, but it cannot keep growing forever because once digital advertising becomes number one, the ceiling will be much closer than we anticipate. Following that will begin a period of stable growth, the same predicament that Apple is facing today. This is the reason why I think Alphabet finding alternative revenue streams, especially ones that are not linked to advertising, will be the key to their long-term growth.

So far, the only moonshots making any money for Alphabet are Nest, health care company Verily, and its high speed internet unit Fiber, which the company intends to invest lots more money into.” - Fortune

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The investment angle

They have had plenty of time, but so far nothing has come out of it. I still have high hopes for Google Fiber as it can add lot of layers and tremendous revenues to Alphabet’s coffers, but, unfortunately, the capital-intensive segment never really took off under the Alphabet’s software DNA. It is possible that they will soon make a breakthrough in wireless internet delivery, which could help creative a viable and high-growth segment for Google.

Self-driving car technology may or may not work, but even if it does, Google will have Tesla and plenty of other car makers to think about in terms of competition. So, in reality, even Other Bets does not seems to have a great answer to Google’s problem outside of Fiber.

The sooner Alphabet is able to identify and nurture the right segment, the better it will be for the long term. For now, investors can enjoy the solid growth in ad revenues and watch as the stock possibly topples Apple from its long-held position at the top of the capital markets ecosystem.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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