I’ve been thinking about Google recently… especially as concerns arose around COVID-19 and what it would do to the new era advertising giants. Everyone knows “search” is such a powerful business in advertising and benefits from the scale / platform benefits of everyone “googling” what they need. Though I can’t help but think that Google’s assets are underappreciated.
I think Google should take a page from IAC. For those of you unfamiliar with IAC, they essentially are a publicly traded venture capital firm. However, unlike VC the business is “home grown” and once it matures, they tend to spin-it out and maintain a stake or take a dividend from the business (like they have recently done with Match Group, the owner of Tinder and other dating apps).
IAC’s track record is impeccable. Recognize any of these names?
The point is, IAC understands that sometimes a company is worth more operating outside of a large corporate umbrella and with its own balance sheet, making its own strategic decisions, and having its own separate shareholders.
They also understand that a company may need to have a shareholder early on with a long-term view. I think Google’s assets could benefit from this treatment as many of them are mature at this point.
Imagine Google does the following spin-offs:
Google Nest, Google Home – Hardware play
Google Maps – logistics tolling play in the long run
Waymo – Driverless Cars
Google Cloud Business
Android, Chromebooks, other hardware etc.
Search, YouTube, & G-suite (Google Sheets, Gmail, Google Drive, Google Pay) is the “RemainCo” as the assets really do benefit from being combined.
Do you think the assets of the company are worth more than what Google currently trades at? I do.
I think YouTube and Google probably are worth where Google trades right now.
Facebook has roughly 50% EBITDA margins on its advertising-driven business. Let’s say Google’s is in a similar ballpark. The company disclosed in 2019 that Google and YouTube generated around $135BN in revenue, so applying a 50% EBITDA margin to that implies $67.4BN in EBITDA. At the time of writing, Google’s entire Enterprise Value is $837BN, so that foots to ~12.5x EBITDA for a company that is a secular grower. That doesn’t seem excessive to me.
Next, lets look at Google Cloud, which is growing like a weed and competes with AWS.
Back when AWS was around this size in revenues, it had low 50% EBITDA margins.
Therefore, I can assume again around 50% EBITDA margins for the Google Cloud business, which foots to $4.5BN of EBITDA. This too is a secular grower, an oligopoly business between the tech giants, and likely going to double earnings in a couple years. Therefore, I do not think its is unreasonable to say this is worth $75BN (frankly, if earnings do double in 2 years, that’s only an 8-9x forward multiple).
The point is though that that one segment could add a lot of shareholder value if it operated outside of Google. We haven’t even touched “other bets” Google has, which seems to be a lot of cookey stuff like barges for some reason.
There are so many things within Google that I bet we don’t even know about. This list of acquisitions by Alphabet is insane and as a layperson, I don’t know what many of them do. Its also hard for me to actually see what value they bring to Google or to me as a shareholder — but if Google separated out its businesses, maybe that wouldn’t be the case!
We’re all locked inside. And that means we’re all watching Netflix, shopping Amazon, and perusing Facebook & Instagram and googling places we wish we could visit. That means all of these companies will benefit from the virus, right? I’m not so sure that advertising revenue is going to hold up that well from Coronavirus. Are Facebook and Google’s revenue at risk from Coronavirus?
“Much of the increased traffic is happening on our messaging services, but we’ve also seen more people using our feed and stories products to get updates from their family and friends. At the same time, our business is being adversely affected like so many others around the world. We don’t monetize many of the services where we’re seeing increased engagement, and we’ve seen a weakening in our ads business in countries taking aggressive actions to reduce the spread of COVID-19.”
This tells me revenue is at risk. Both Facebook and Google sell ads… and those ads are sold to small-and-mid-sized businesses which have seen an unprecedented impact from Coronavirus. The tech giants have been growing superbly well as they take share in advertising, but weren’t really around in the past downturn. Therefore, the business model hasn’t really been tested through a real recession.
Advertising is cyclical. This makes some intuitive sense. When business is going well, you have extra funds left over that can be used for generating more sales. Or competition is higher because there is room for it and so you need to maintain market share. YOU may even be the new entrant trying to gain that share.
In a downturn, cuts have to be made. If I am a restaurant, I can’t really sacrifice much on food costs or labor or else my customers may have a bad experience. If I also have a feeling that consumers don’t really want to spend money right now (e.g. unemployment is going up) then why not cut my advertising spend? It ripples through the chain.
As the saying goes, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” This has historically resulted in cuts to spend since CEOs don’t feel like they are getting the bang for the buck.
Here is a snapshot of “old school” advertising companies’ peak-to-trough in the Great Financial Crisis (GFC).
Note, for the TV broadcasters I am using 2-yr average results given election years play a factor in results.
I also use gross profit given incremental margins matter so much in advertising. Quick Segway: If I have an existing network of 10 billboards in a town and 9 of them are on rent, you can see how getting that last billboard on rent would result in meaningful profit to the bottom line. My sales go up ~11%, but my costs barely go up. True in nearly all advertising and very true for Facebook and Google. Ok back to the main points.
What Can We Expect from the Tech Behemoths
I highly doubt many people are truly thinking about Facebook or Google’s earnings declining at all in 2020, but it’s something worth pondering.
Facebook on its Q4’19 earnings call stated there are now, “140 million small businesses that use our services to grow.” Google, in its filings, specifically discusses how its targeted ads let small businesses connect with customers.
If the virus ripples through our economy, taking down small restaurants and bars, local gyms, and people pull back on buying cars from their local auto dealer — that could clearly impact Facebook and Google’s ad revenue. With most restaurants closed right now, why would I advertise as much?
Unfortunately, it’s impossible to see where Facebook and Google make their money by segment. It’s much easier to know that Yelp generates most of its money from restaurants promoting themselves in a competitive field. Not true for the tech behemoths though.
We have some financial history with Google, given its IPO was in 2004. The problem is that it was secularly growing during the GFC. Google does $162BN of revenue today. It did $16.6BN in 2007 at the “market peak”. It kept growing through the GFC, though growth did slow to just 8.5% in 2009 over 2008.
Sell side estimates currently expect 16.7% growth in 2020 for Google… on much larger numbers. Facebook is expected to grow 20%. These may prove aggressive.
Impact from the Virus
I do not think it is out of the realm of possibility that we could see sales growth slow meaningfully for the tech giants. This will lead to a reset of expectations, though admittedly, the two ad tech giants trade for reasonable multiples (believe FB is 12x earnings ex-cash). My larger fear is the reset of investors’ view of the business as whole — they may no longer be bulletproof.
That said, if I am in charge of an ad budget, this may accelerate my shift away from traditional media and to Facebook and Google. People are at home, shopping online, then why not. Plus, its super-high ROI advertising spend. In other words, I don’t pay Google unless someone clicks on the ad, so I’m only paying if the ad works.
This dynamic may finally get rid of the adage I mentioned above – I now know if my ad is working. And because of this we could see more resiliency out of the new advertising names and it could be a bloodbath for traditional names. However, it still holds true that I’m not going to buy an ad, or at least as many, when I’m struggling to pay payroll or rent.
Separate Challenges for Google
Google has been expanding in the travel space, in fact encroaching on ground owned by Booking’s Kayak or Expedia. Booking said in its latest 10-K:
Some of our current and potential competitors, such as Google, Apple, Alibaba, Tencent, Amazon and Facebook, have significantly more customers or users, consumer data and financial and other resources than we do, and they may be able to leverage other aspects of their businesses (e.g., search or mobile device businesses) to enable them to compete more effectively with us. For example, Google has entered various aspects of the online travel market and has grown rapidly in this area, including by offering a flight meta-search product (“Google Flights”), a hotel meta-search product (“Google Hotel Ads”), a vacation rental meta-search product, its “Book on Google” reservation functionality, Google Travel, a planning tool that aggregates its flight, hotel and packages products in one website and by integrating its hotel meta-search product into its Google Maps app.
This is a problem for Booking and Expedia because they use Google to generate leads for their own sites. While Google may eventually consume these businesses, they also represent non-trivial amounts of their revenue.
Our performance marketing expense is primarily related to the use of online search engines (primarily Google), meta-search and travel research services and affiliate marketing to generate traffic to our websites.
How much was “performance marketing” expense? $4.4BN in 2019 for Booking and $3.5BN for Expedia.
I bring all of this up for a reason: While Google may eventually compete away these businesses — today they matter. And those businesses are likely being crushed by the lack of travel demand right now, which will mean less spending with Google. These are just two companies, but ~5% of revenue for Google. Now imagine every hotel chain, restaurant, airline and so on also pulling back… Now weave in the decremental margin we discussed earlier…
This virus is truly something we haven’t seen before. It permeates everything we touch. Long-term, I think Facebook and Google are amazing businesses to own, but don’t be surprised if 2020 is a hiccup and expectations are reset. It’s quite possible they suck up ad revenue that is lost from radio, TV, etc., but it also could be a very large hole to fill.