The company formerly known as Google, Alphabet, has a pristine balance sheet and generates a tremendous amount of free cash flow. A paid search powerhouse that is making some big bets in other areas of the future is one of our favorite ideas. The Valuentum analyst team digs in. ~6 minutes
Please access the transcript below.
Tickerized for Google, Twitter, Facebook, and various Internet ETFs.
Brian Nelson, CFA:
This is Brian Nelson for Valuentum Securities and welcome to our podcast. Today I have joining me Mr. Kris Rosemann and Mr. Chris Araos. The topic today is going to be on Google, now calling itself Alphabet. Google is a company that we include in our Best Ideas Newsletter portfolio — ticker symbol GOOG and GOOGL. Mr. Kris Rosemann tell us why we like Google?
Kris Rosemann:
Google is one of the most innovative firms out there. It continues to throw off tons of free cash flow, and it has an impressive cash position in its balance sheet to the tune of about $78.5 billion in cash and cash equivalents, as of the end of the second quarter of 2016. I think the proper way to think about Alphabet as a company — it has seven core products which include Google search, YouTube, Google Chrome, Gmail…
Brian:
It has a whole suite of products…
Kris:
What’s important to note is that all seven of those core products it notes as its core suite have over 1 billion monthly active users, each one has over 1 billion users…
Brian:
That’s really incredible — because when we think about Facebook (FB), Twitter (TWTR), Instagram, Pinterest, and the list goes on and on about all the competition that Google has encountered, even in the past years, the fact that it is still growing its revenue at a 20% clip, that it’s throwing off gobs and gobs of free cash flow, has a mountain of cash on the books despite all this competition, despite the landscape (it’s ever-evolving) — it speaks to its competitive advantages and its staying power. It’s clear to us that the Facebooks of the world, the Twitters of the world, while they have advertising platforms, they’re not going to be able to unseat Google in search, both on the desktop and mobile.
Kris:
There are a number of other businesses within what it calls ‘Other Bets’ and just the fact that this ‘Other Bets’ segment exists we think is a testament to the free cash flow generating power and the high operating margin power of Google’s core product suite. If you think about the other bet segment – it lost almost a billion dollars in the second quarter of 2016 alone, and they were still able to grow overall operating income by a significant amount.
That ‘Other Bets’ segment right now consists of things like the Nest Smart Thermostat, hardware technology sales, healthcare licensing and R&D services, as well as Internet and TV services through the Google fiber product. Its well-known Google has been working on its self-driving cars.
They recently announced that they plan to separate that business within their parent holding company Alphabet — and what that means is that they are expected to begin generating revenue in the coming years, which is pretty incredible when you think about where we are and where we have come with respect to self-driving cars.
Brian:
Sounds like they’re expecting this to be a pretty significant long-term driver of their business in terms of profitability as well, if they’re willing to segment this particular division. Now, it could also spell the idea that long term they could carve this out into a new entity, publically-traded entity, or even merge it or use it as a platform to acquire other technologies within the self-driving area.
So this is a very, very interesting development, but we also have to keep everything in the context here while their ‘Other Bets’ business is something we’re paying attention to for the long-term prospects of Google and Alphabet, yoday this portion of their business is immaterial when it comes to the revenue side of things
It’s generating less than a billion dollars on annual run-rate in revenue versus Google’s massive revenue base, and it’s losing about a billion dollars on a quarterly run-rate, which is pretty hefty compared to what Google is generating in terms of its operating earnings — roughly seven billion or so on a quarterly run rate basis. So its absorbing a lot of the company’s resources and profits, to a degree, but it also is an important part of their long-term picture, and I think Google as Mr. Rosemann mentioned is really focused on the innovation side of things — what are some of the things that Google and Alphabet maybe able to develop over the next five to ten years is really, really fascinating, as it leverages its cash cow search business to invest in these new technologies.
Kris:
That’s not to say that their core product suite is nearing a material saturation point by any means. The entire globe doesn’t have access to high-speed Internet that many of Google’s products demand, and that’s something they see as a material driver in coming years, as the increasing globalization of our world really will drive demand for their products.
One interesting thing that they’re working on is ‘Project Loon,’ which is kind of another of these “out there” ideas right now, but they’re looking to find a way to broadcast Internet to remote parts of the world which would obviously increase the uptake and there in demand for their products.
Brian:
It seems like they have pretty much the entire picture. They have substantial moaty dynamics in their search business, potential upside with their ‘Other Bets’ operations, a huge and robust cash position, net cash position on the balance sheet, substantial free cash flow generating capacity, and potentially the wherewithal to start buying back stock aggressively and potentially even initiating a dividend as many big cap tech stocks have done.
This is Brian Nelson. Thank you very much for joining us.