Addition date
Nov 3, 2022 10:55 AM
Column
Raphael ThysLAN
EN
Hello there! 👋
Greetings from San Francisco!
Welcome to the new members who have joined us this week!
Join the thousands of How They Make Money subscribers receiving insights on business and investing every week.
Alphabet (GOOG) (GOOGL), the parent company of Google, reported its Q3 FY22.
Today, we’ll cover the following:
- Alphabet Q3 FY22.
- Recent business highlights.
- Key quotes from the earnings call.
- What to watch looking forward.
CB Insights provides an excellent overview of Alphabet’s divisions:
Before we start, let’s discuss how Alphabet makes money:
- Revenue has four main components:
- Advertising (~80% of revenue):
- Google Search ads (Google.com, Gmail, Maps, Play).
- YouTube ads.
- Google Network (AdMob, AdSense, and Ad manager).
- Google Cloud (~10% of revenue) includes Google Cloud Platform (infrastructure) and Google Workspace (cloud-based collaboration).
- Google Other (~10% of revenue) includes the Google Play store fees, Youtube Premium & TV, and hardware (Fitbit, Nest, Pixel phones).
- Other Bets (< 1% of revenue) include health technology and services.
- Cost of revenues includes TAC (traffic acquisition costs), which is the amount paid to distribution partners (e.g., Google pays Apple to be the default search engine on Apple devices). Other cost of revenues includes content acquisition costs (payments to content providers on YouTube and Google Play).
- Margins: Google Services (Advertising + Other) have a 32% operating margin, while other segments (Cloud and Other bets) are still loss-making and early in their growth phase.
1. Alphabet Q3 FY22
Income statement:
Here is a bird’s-eye view of the income statement.
Revenue by segment (growth Y/Y):
- Advertising $54.5 billion (+3% Y/Y).
- Google Search & other $39.5 billion (+4%).
- YouTube ads $7.1 billion (-2%).
- Google Network $7.9 billion (-2%).
- Google Cloud $6.9 billion (+38%).
- Google Other $6.9 billion (+2%).
- Other Bets were $0.2 billion, and hedging gains $0.6 billion.
Main highlights:
- Revenue grew +6% Y/Y to $69.1 billion or +11% fx neutral (vs. $70.8 billion expected).
- Gross margin 55% (-3pp Y/Y).
- Operating margin 25% (-7pp Y/Y).
Cash flow:
- Operating cash flow was $23.3 billion (34% margin).
- Free cash flow was $16.1 billion (23% margin).
Balance sheet:
- Cash, cash equivalent, and marketable securities: $139.7 billion.
- Long-term debt: $28.4 billion.
So what to make of all this?
- The strong dollar generated a 5pp headwind, making the growth number artificially muted. The growth in constant currency was +11% Y/Y and is a better representation of the business performance.
- Advertising saw a slowdown, but a tough year-over-year comparison was partially to blame. For context, Q3 FY21 was a very strong quarter. At the time, Google Search grew +30% Y/Y, and YouTube ads grew +43% Y/Y.
- The uncertain environment is a significant factor. For example, management noted a pullback in spending in the financial services category.
- Google Other grew +2% Y/Y. YouTube Music, Premium, and TV saw strong growth, partially offset by some softness in Google Play spending (particularly gaming, lapping a very strong Q3 FY21).
- Google Cloud was a bright spot in the report. The revenue growth accelerated to +38% Y/Y (from +36% in the previous quarter), and the segment's operating loss margin improved to 10% (+3pp Y/Y, +4pp Q/Q).
- The margin contraction was explained by the revenue mix, the fx headwind, and Google’s investment in its technical infrastructure.
Q4 Outlook:
CFO Ruth Porat expects a more significant fx headwind in Q4. In addition, she expects continued softness for Google Play based on user engagement in gaming. Management plans to slow the pace of hiring through 2023.
Is the business sustainable?
Alphabet has a fortress balance sheet and is printing money with more than $65 billion in free cash flow generated in the past year. However, it’s essential to note advertising is a cyclical business and doesn’t grow in a straight line.
2. Recent business highlights.
- Realigning resources: Management is shifting headcount to fuel higher growth opportunities. They plan to hire at a much lower pace in Q4, which is still remarkable in the context of massive layoffs at many tech companies.
- Google Lens answers 8 billion questions every month. 👀
- YouTube is ~10% of the overall revenue. It remains a big priority. YouTube has 2 billion monthly signed-in users. Following the transition from desktop to mobile, the platform has a significant opportunity in short-form videos, a format meant to compete with TikTok and other social media apps. Shorts have 1.5 billion users monthly. The company will introduce revenue sharing on Shorts early next year. YouTube Shorts is now averaging 30 billion daily views (~4x Y/Y). Additionally, YouTube TV recently crossed 5 million subscribers. YouTube took the #1 spot in US TV time for the first time in September.App Economy Insights @EconomyAppShare of US TV Time (9/2022). • 37% Streaming • 34% Cable • 24% Broadcast • 5% Other (including gaming) Streaming breakdown (37% of total): • 8.0% YouTube $GOOG • 7.3% Netflix $NFLX • 3.8% Hulu • 2.9% Prime Video $AMZN • 1.9% Disney+ $DIS • 13.0% Other Streaming 1:03 AM ∙ Oct 21, 2022190Likes65Retweets
- Google Cloud is ~10% of the revenue. Google Cloud grew +38% Y/Y, ahead of Microsoft Azure (+35% Y/Y in Q3 FY22). Google has a ~10% market share of the cloud infrastructure services market in 2022.App Economy Insights @EconomyAppWW Cloud Infrastructure Market Share. Q2 2022 update: • $AMZN 34% • $MSFT 21% • $GOOG 10% • $BABA 5% • $IBM 4% • $CRM 3% • $TCEHY 3% • $ORCL 2% 3:58 PM ∙ Aug 4, 2022196Likes63Retweets
- 8 million businesses use Google Workspace.
- In September, Google closed its acquisition of cybersecurity firm Mandiant to add threat intelligence to Google Cloud.
- Other bets: Los Angeles will be the third ride-hailing city welcoming Waymo (after Phoenix and San Francisco).
3. Key quotes from the earnings call
CEO Sundar Pichai on management’s priorities:
“We are sharpening our focus on a clear set of product and business priorities. The product announcements we have made in just the past month alone have shown that very clearly, including significant improvements to Search powered by AI, new ways to monetize YouTube Shorts, which will support the creator ecosystem, the strong series of hardware launches and a new partnership and product announcements at Cloud Next.”
About AI:
“We’ve been an AI-first company for the past seven years in all the investments.”
Pichai compared the current AI transition to the shift to mobile in the early 2010s:
“Over a decade ago, focusing the Company’s efforts on mobile helped us to build and grow our business for the shift to mobile computing. We are at a similar point now with AI, another transformational technology. Our investments in AI and deep computer science mean that we can deliver a wide range of breakthroughs across our products and services to help people, businesses and communities.”
About the broader macro environment, he added:
“Over time, we’ve had periods of extraordinary growth, and then there are periods where I viewed it as a moment where you take the time to optimize the company to make sure we are set up for the next decade of growth ahead. I view this as one of those moments.”
Chief Business Officer Philipp Schindler was upbeat on YouTube’s future:
“YouTube remains in a really good position to continue to benefit from the streaming boom. In direct response, we think there’s a lot of room to run to make really YouTube more shoppable, more actionable from video action campaigns to product feeds, app campaigns, live commerce features.”
4. What to watch looking forward
Artificial Intelligence:
Google is trying to solve society’s biggest challenges with AI. And it’s become increasingly good at it.
- DeepMind: Google acquired the British artificial intelligence company DeepMind for $500 million in 2014. Its algorithms have significantly increased the efficiency of cooling Google’s data centers, helped with Google Play's personalized app recommendations, and provided features like Adaptive Battery and Adaptive Brightness for the Android OS.
- Natural Language Processing: Google’s AI chatbot generator has become so good that engineer Blake Lemoine went public with claims that it was sentient. Do you remember the movie “Her,” with Joaquin Phoenix falling in love with an operating system? It’s happening.
- Generative AI: They are programs that can use existing content (text, audio files, or images) to create new plausible content. You might have heard about a 20-minute chat between Joe Rogan and Steve Jobs, entirely AI-generated. This technology could improve and personalize ad experiences at scale. Imagine being served an ad that factors your favorite color, your favorite sports, or based on your recent activities. Below is an example of an image made by Google’s Imagen AI based on a text prompt.
"A cute corgi lives in a house made out of sushi," made by Google’s Imagen AI
Antitrust cases:
- Ad-tech: Google is operating on multiple sides of the advertising transaction, which puts it in a dominant position. The DOJ is reportedly prepping an antitrust suit. The firm is at risk of facing another hefty fine in the EU over its adtech business due to a potentially unfair advantage over rivals and advertisers (Google has paid more than 8 billion euros in EU antitrust fines in the past 10 years).
- Google Play Store billing: India fined Google $113 million for abusing the dominant position of its Google Play Store and ordered the firm to allow developers to use 3rd party payment processing services. It’s a slap on the wrist for a company the size of Alphabet, but the decision could have consequences in other regions. Earlier this year, Match Group sued Google, alleging anticompetitive app store behavior.
Google has a search monopoly, but not without risk:
- According to eMarketer, Google will remain the market leader in digital ad revenue, with market share only marginally shrinking.
- Google holds a more than 92% share of the US search market. But the firm pays billions of dollars each year to Apple, Samsung, and other telcos to maintain its dominance.
- New entrants could challenge the status quo. Apple plans to show ads in Apple Maps starting next year and could make a more significant push. Digital search is evolving across TikTok (discovery), Amazon (products), Instagram (trends), and Snap Maps (local businesses). You probably have heard that TikTok is the new search engine for Gen Z. Google Senior VP Prabhakar Raghavan explained:
“In our studies, something like almost 40 percent of young people, when they’re looking for a place for lunch, they don’t go to Google Maps or Search. They go to TikTok or Instagram.”
Overall, Google is an AI juggernaut with tremendous potential ahead. But it cannot rest on its laurels to remain your favorite verb.
That’s it for today!
Stay healthy and invest on!
Subscribe to How They Make Money so you don’t miss any updates.
Disclosure: I am long GOOG in the App Economy Portfolio. I share my GOOG rating (BUY, SELL or HOLD) with App Economy Portfolio members here.