For Google, all roads lead back to search

Once their revenues reach $100bn, most companies are destined for comfortable maturity. The law of large numbers kicks in.

Not so for Google. The search advertising market may be 20 years old, but growth at the internet company has re-accelerated over the past three years. As a result, parent Alphabet — which gets 99.5 per cent of its revenue from Google — is expected this year to turn in its highest growth rate since 2011, even though its revenue will be nearly four times greater than it was then.

The $26bn in new business likely to be added this year is a stunning demonstration of the enduring power of Google’s core business. It also points to the health of a cash machine that has been funding the company’s next big businesses, fuelling its growth well beyond search.

If Alphabet can maintain this momentum and get past its current margin-crimping investment phase, its shares should be able to maintain their current earnings multiple over the next three years, said Dan Chung, chief investment officer at Alger, a growth-oriented fund manager in New York. That points to 30 per cent upside in the stock over the same period, he added, something that would lift Google’s market capitalisation close to the $1tn mark.

Despite the strong recent performance and growth potential, there have been clouds overhanging Google’s share price this year. They start with the escalation in spending that has unnerved some investors in recent months.

“If there’s a frustration for Alphabet shareholders, they don’t do a good job of giving visibility into their businesses,” said Jim Tierney, chief investment officer at AllianceBernstein’s Concentrated US Growth Fund, voicing a common complaint. “I trust them over the long term — but it would be really nice to have some milestones along the way.”

A bigger concern weighing on the stock has been the threat of a political and regulatory backlash fuelled by Google’s growing power. “The biggest risk is clearly privacy regulation, and also their monopolistic control of certain segments,” said Mr Chung.

But if it can navigate issues like these, then many Wall Street analysts believe Alphabet is on the verge of a strong growth spurt that will carry its revenue past $200bn by early in the next decade.

Underpinning this is the mobile business, which has given Google’s search engine a new lease of life. With smartphone users carrying out more frequent internet searches, the “paid clicks” — the number of times users click on its advertisements — jumped 59 per cent in the first three months of this year, continuing an acceleration seen over recent quarters. Even with average ad prices falling 19 per cent, the result has been a pick-up in growth.

The question now is whether Google’s newer businesses will extend this momentum into new markets in the years to come. Foremost among them is YouTube. The online video arm already has $20bn in annual revenue and could grow at 20-30 per cent a year for the next five years, forecast Mark Mahaney, an analyst at RBC Capital Markets.

The potential is enormous: YouTube’s revenue represents only around 10 per cent of the amount spent globally on traditional TV advertising, said Youssef Squali, an analyst at SunTrust Robinson Humphrey. “The good news is, it’s still thoroughly early for YouTube,” he said. “That’s where the eyeballs are going.”

Google’s cloud computing business, meanwhile, could represent an even bigger opportunity.

The race to a trillion, Alphabet market cap

Google made a late start and, with annualised revenue currently standing at around $4bn, it is well behind market leaders Amazon and Microsoft. But it has finally thrown its weight behind a serious attack on the market, and offering other companies access to the artificial intelligence developed for its own services could be a powerful lure.

“They may have the best AI/machine learning capabilities on the cloud,” said Mr Chung.

Further off, Alphabet’s so-called “other bets” — which include biotech, broadband networks and driverless cars — offer the chance of growth in entirely new markets. But most investors and analysts have not yet tried to assess their business potential or include them in their valuation models.

Commenting on driverless car unit Waymo, RBC’s Mr Mahaney said: “What the long-term revenue model is going to be is very unclear — it’s at least five years in the future.” But he added that Waymo’s clear lead in the field might one day put it in a position to sell its software to many different carmakers, much as Microsoft’s Windows software became the standard for PCs: “I think they’re creating the autonomous vehicle system for all cars.”

Kevin Walkush, a portfolio manager at Jensen Investment Management, forecast that Waymo could make even more money from the business Google knows best: guiding people around the internet. “Everything leads back to core search,” he said. “All these people will be sitting in vehicles and doing what? They’ll be online. It’s a way to facilitate core search, and to maximise the value of the network.”

That could one day make driverless cars a huge business for Google. Analysts at UBS forecast that Waymo’s technology lead will translate into revenues for Alphabet in 2030 that are equivalent to 80 per cent of its entire group revenue in 2020.

But with the current stall in its price and future businesses like this still hard to evaluate, Wall Street may be slow to give Google credit. “I think Amazon will get to a trillion dollars first — but Alphabet will get there too,” said Mr Squali.

Coming later this week: What is driving Amazon and Microsoft towards a $1tn valuation?

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