Google started with Larry Page, Sergey Brin and Scott Hassan developing a new search engine with an improved algorithm. Even though Hassan did most of the coding, he left to start a career in robotics. After it’s IPO in 2004 Google started major acquisitions in other companies like Youtube. In a restructuring in 2015 Google was transformed into Alphabet, which became it’s parent company.
Core Business
Google’s operations are divided in three categories: Google Services, Google Cloud and so called “Other Bets” consisting of several ventures including A.I., robotics, autonomous driving and pharmacy. As Google Services and Google Cloud generate >99% of Google’s revenue I won’t go into much detail on the “Other Bets” Category.
Relevant Acquisitions
Through it’s acquisition activity google amassed around 250 acquisitions, expanding their research capabilities in fields like A.I., quantum computing and robotics. Below the most important ones are summarized.
Youtube
The most famous one of all Google acquisitions. Purchased in 2006 for 1.65 billion dollars Youtube has risen to world wide success and an unchallenged standing almost as relevant as it’s parent company. With revenues as high as 28,8 billion dollars (2021), it generates over 10% of Google’s revenue. It has proven to further expand their earnings-power besides ads with it’s Youtube Premium and Music subscription, which according to Alphabet was the major contributer to an increase of $6.3 billion in Google’s “Other Revenues” (1).
DoubleClick
DoubleClick was an ad service provider, who worked with advertising agencies and served major brands like Coca-Cola, GM and Microsoft. After it’s acquisition in 2008 for $3.1 billion lots of customer relations and technology was integrated into Googles ad business. In 2018 Google announced it’s plan to rebrand all ad platforms and merged DoubleClick with Googles own ad platform into the new Google Marketing Platform (2).
Motorola Mobility
When Google acquired Motorola in 2011, the company was struggling to gain a foothold in the smartphone business and reported the fifth straight quarter of losses. The company cost $12.5 billion dollar, Google’s largest acquisition, and was motivated as a strategic move to increase Google’s patent ownership and defend the Android operating system. After closing the deal Google sold parts of the business to Arris Group for $2.35 billion and led the smartphone division to success through a focus on high-quality entry-level smartphones. In 2014 Google sold Motorola for $2.91 billion, while keeping a major part of the patents. (3)
Mandiant
Google announced that Mandiant would be acquired in March 2022, to get integrated into the Google Cloud division.
Fitbit
Fitbit, a producer of wearable technology was acquired by Google in January 2021 and integrated into it’s hardware division.
Nest Labs
To expand it’s home automation business Google acquired Nest labs in 2014 for §3.2 billion and merged it with the Google Home brand in 2018 to create Google Nest.
Industry Enviroment / Competition
Advertising
Through it’s search engine and Youtube, Google generates significant revenue with advertisment campaigns for it’s customers. It is unchallenged with a market share of 92% for it’s search engine and Google Chrome leading the browser market with 65% (4). Competition in it’s most relevant business is almost irrelevant for it’s earnings power and market position as most major players (Microsoft with Bing, Yahoo) have failed to attack it.
Google Cloud
In the highly competitive cloud computing industry Google competes with giants like Microsoft, Alibaba and Amazon. It isn’t in a leading position, but increased it’s market share from 5% (2017) to 10% (2021) with only AWS and Microsoft Azure above. (5) (6)
Income Statement
Revenue Growth
Google’s revenue has increased by an average of 21% annually in the last 10 years. With Growth accelerating in the past 5 years (23,3%), the question should be if similar growth can be expected in the future.
Google’s main business of advertising stands as strong as we have discussed above and with more digitilization and e-commerce growth not slowing down the market for it’s search engine and it’s ads will continue to grow. Growth projections in that business reach from 11% to 15%. (8) (9)
As Google Cloud has gained more market share in the last years and has grown it’s revenue by more than 40% on average, it’s safe to say that it will grow at least as much as the overall cloud computing industry if not more. In a recent market research report a Compound Annual Growth Rate (CAGR) of over 16% was forecasted until 2026. We will take that at face value for our worst case scenario and will add to it as in a best case scenario, Google will gain more market share. (10)
Cost Development
Costs as a Percentage of Revenue (Table 1)
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|---|
| Cost of revenues | 38,92% | 41,12% | 43,52% | 44,42% | 46,42% | 43,06% |
| R&D | 15,45% | 15,00% | 15,65% | 16,07% | 15,11% | 12,25% |
| Sales and Marketing | 11,61% | 11,63% | 11,94% | 11,41% | 9,83% | 8,89% |
| General & Admin | 7,74% | 6,20% | 5,94% | 5,90% | 6,05% | 5,24% |
| European fines | 0,00% | 2,47% | 3,71% | 1,05% | 0,00% | 0,00% |
Cost Development as a Percentage of Revenue (Table 2)
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|---|
| Cost of revenues | 5,64% | 5,85% | 2,06% | 4,51% | -7,24% | |
| R&D | -2,94% | 4,39% | 2,68% | -6,02% | -18,90% | |
| Sales and Marketing | 0,13% | 2,64% | -4,44% | -13,81% | -9,55% | |
| General & Admin | -19,88% | -4,19% | -0,65% | 2,61% | -13,40% | |
| European fines | 50,17% | -71,71% | -100,00% |
Cost Development in general (Table 3)
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|---|
| Cost of revenues | 5,64% | 5,85% | 2,06% | 4,51% | -7,24% | |
| R&D | -2,94% | 4,39% | 2,68% | -6,02% | -18,90% | |
| Sales and Marketing | 0,13% | 2,64% | -4,44% | -13,81% | -9,55% | |
| General & Admin | -19,88% | -4,19% | -0,65% | 2,61% | -13,40% | |
| European fines | 50,17% | -71,71% | -100,00% |
In recent history Google was able to decrease different parts of it’s costs effectively, thus increasing profitablility. Cost of revenue is made up of ****traffic acquisition costs (TAC) and other revenue costs. TAC consists of payments made to traffic distributors, giving Google the platform and audience to advertise for it’s clients.
Other revenue costs consist of licensing fees for acquired content sold on YouTube and Google Play, expenses in it’s data centers and costs related to Google’s hardware business.
Composition of cost of revenue (COR) (Table 4)
| Cost in ($ Mio)/Year | 2020 | 2021 |
|---|---|---|
| TAC | 32,778 | 45,566 |
| Other COR | 51,954 | 65,373 |
| Total COR | 84,732 | 110,939 |
With past cost development it’s important to use the studied data to make forecasts into the future regarding revenue, cost and profit development to feed our DCF model. We will look for patterns in which relation costs follow growing revenue. With the following table I will try to point that out.
| 2013-2014 | 2014-2015 | 2015-2016 | 2016-2017 | 2017-2018 | 2018-2019 | 2019-2020 | 2020-2021 | Average | |
|---|---|---|---|---|---|---|---|---|---|
| Revenue Growth | 18,88% | 13,62% | 20,38% | 22,80% | 23,42% | 18,30% | 12,77% | 41,15% | 21,42% |
| COR | 16,81% | 9,63% | 24,76% | 29,73% | 30,64% | 20,73% | 17,85% | 30,93% | 22,64% |
| R&D | 37,76% | 24,92% | 13,56% | 19,19% | 28,84% | 21,47% | 5,98% | 14,47% | 20,77% |
| Sales and Market | 24,06% | 11,27% | 15,89% | 22,97% | 26,68% | 13,05% | -2,81% | 27,67% | 17,35% |
| General&Admin | 32,02% | 4,87% | 13,84% | -1,62% | 18,25% | 17,54% | 15,72% | 22,24% | 15,36% |
The cost of revenue has trailed revenue quite close and I expect it to continue to be around 40-43% of all revenue. R&D expenses have risen with revenue but have slown down in recent years. It’s not attached to revenue growth directly, but we will assume a small average growth of 10% for the upcoming years as the R&D expenses are already high enough to guarantee Google to be a potential player in all upcoming high-tech industries. Further reductions in the SGA expenses relative to revenue is possible with revenue outpacing those costs, as it has been seen in the past. Still we will assume it too be just stable to have a more conservative approach.
Balance Sheet
Debt Level
Google’s long term debt is almost non-existing with $15 billion. It’s earnings were >$70 billion in 2021 so it’s debt could have been paid off with just 20% of that. The company also hold’s $21 billion in cash, which makes debt for the valuation almost irrelevant.
Capital Intensity
As Google’s business needs large amounts of land, offices and server infrastructure. Aside from large marketable securities positions, most capital is tied up in purchased land, offices and information technology assets like server farms. The company is determined to expand it’s position in that area, which will result in rising capital expenditures for both new offices and new IT assets. (1)
Liquidation Value / Tangible Book Value
To calculate the Tangible Book Value I will use the most recent book value and exclude all assets I think are intangible. TBV calculation in $billion:
| Book Value | 254,004 |
|---|---|
| -Goodwill | -23,010 |
| -Property and Equipment | -104,218 |
| -Other non-current assets | -5,778 |
| TBV | 120,998 |
Note: I didn’t exclude smaller positions as it would make the formular unnecessarilly large with no real effect. It’s also quite reasonable as normally the Property and Equipment of Google of cause could be sold for at least a fraction of the audited value.
Google has a TBV per share of: $120998 million / 673.22 million shares = $179,73 per share
Cashflow Statement
IT assets generally have a high turnover frequence which results in short depreciating periods (4-5 years). The replacement makes up a large portion of the $24.6 billion of capital expenditures, which are needed for the business operation.
Still Google has great liquidity through it’s short-term marketable securities and it’s large cash reserves.
With almost over $60 billion dollar of free cashflow, Google used most of it ($50 billion) to make stock repurchases. Still the company has only really started to do repurchases in the last 4-5 years and because of it’s high valuation the amount of shares outstanding has only decreased by 5% in 3 years, which is quite a disappointment (11). $15 billion were paid in stock compensation and to account for that we won’t add it back into the DCF-valuation even though it’s a non-cash expense.
Other
Insider Trading / Ownership
Insider Trading has no significance for Google as high management only sold insignificant portions of their ownership. (12)
The founders Larry Page and Sergey Brin still have small stakes in the company of around 3% each, even though they slowly continue to sell them off. There is also no insider with a significant stake in the company. (12)
Risks
- Lower advertising spending by customers
- Google’s value for it’s customers could decline
- Competition disrupting the occupied markets
DCF Model
Summary of the Assumptions made:
- The revenue of Google Services will increase with the projected growth of the overall market of 11%-15%, which is conservative as parts like Youtube are growing at much higher rates
- Google Cloud’s revenue has increased at an annual growth rate of over 40%. In a worst case scenario it will grow at a CAGR of 16% in line with it’s industry projection, but there is a real possibility of it to accelerate at the current rate until it has gained enough size. Our worst, base and best case projection will still stay conservative at 16%-24$
- As COR is staying volatile around 45% of revenue we will assume it to stay at that level
- R&D will rise around 10% every year unrelated to revenues
- SGA (sales, general, administration) expenses will stay at the current level of 14% relative to revenues and won’t decrease any further
- capital expenses have remained quite stable at around $24 billion dollars. We will still assume an increase of 10% per year as in the most recent 10-Q report the capex has risen by over 40%.
- Depreciation rises at CapEx rate
- 2021 is not an outlier
- Share repurchases will range between 2-5% per year, as those are highly dependent on the share price
We will use a projection of the next 15 years to determine Google’s fair value in 3 scenarios at a discount rate of 8%
| Worst Case | Base Case | Best Case | |
|---|---|---|---|
| Google Ads CAGR | 11% | 13% | 15% |
| Google Cloud CAGR | 16% | 20% | 24% |
| COR | 45% of total rev | “” | “” |
| R&D CAGR | 10% | “” | “” |
| SGA | 14% of total rev | “” | „” |
| CapEx and Depreciation | 10%“” | „” | |
| Share repurchases | 2% | 3,5% | 5% |
| Fair Value | $1690 | $2518 | $3805 |
I would consider te base case to be highly plausible as past growth has indicated much higher growth rates. Of course it’s up to you to choose your margin of safety, but I will consider to pick up some shares if Google falls below $2000.
Sources
(1) https://www.sec.gov/Archives/edgar/data/1652044/000165204422000019/goog-20211231.htm
(2) https://en.wikipedia.org/wiki/DoubleClick
(3) https://en.wikipedia.org/wiki/Motorola_Mobility
(4) https://gs.statcounter.com/browser-market-share#monthly-201407-202204
(7) https://www.sec.gov/Archives/edgar/data/0001652044/000165204418000007/goog10-kq42017.htm
(8) https://www.grandviewresearch.com/industry-analysis/e-commerce-market
(9) https://www.statista.com/outlook/dmo/ecommerce/worldwide
(10) https://www.marketsandmarkets.com/Market-Reports/cloud-computing-market-234.html
(11) https://www.macrotrends.net/stocks/charts/GOOG/alphabet/shares-outstanding
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