Alphabet's march to snatch Apple's crown

The revenue rise an increase of 24 per cent to $21.3 billion was attributed to strong growth in mobile search and YouTube

Wall Street got its first glimpse of the financial details of a new conglomerate called Alphabet on Monday. Investors liked what they saw so much that the outfit formerly known as Google is poised to become the world’s most valuable company.

Despite spending $3.6 billion a year on projects like self-driving cars that don’t make much money, Alphabet’s advertising business propelled the company to a strong last three months of 2015, outpacing expectations and sending the stock up in after-hours trading.

Alphabet will most likely be worth more than Apple, which has been the most valuable company in the world for nearly four years. Apple is still generating enviable profits but is dealing with concerns that its franchise iPhone business is slowing down.

If investors are sending any sort of signal to big tech companies, which have taken their lumps from shareholders this year, it is simply this: You are free to spend on side projects so long as your main business is not showing signs of weakness. “The main thing is the core business,” said Josh Spencer, who manages T Rowe Price’s Global Technology Fund.

The results were the first foray of Alphabet, which unveiled its reorganisation plan last summer, into segment reporting. That means that for the first time, the company is letting investors see its search and advertising businesses — now a subsidiary called Google Inc — next to the costs of the various projects like self-driving cars, which generate a lot of talk but not much money.

Alphabet’s total revenue, barring currency fluctuations, increased 24 per cent to $21.3 billion, when compared with the same period in 2014.

Analysts will spend the next few days using those results to rejig the models they use to rate Alphabet’s stock. In a conference call to discuss the results, they found innumerable ways to ask two simple questions: How fast is the traditional Google business growing, and how much of its money will be funnelled toward “moonshot” projects like self-driving cars and drones that deliver packages?

The revenue rise was attributed to strong growth in mobile search and YouTube, which is significant because investors had long been looking for signs that the core search business was making a smooth transition from desktop computers to mobile phones, and that YouTube was becoming a driver of new growth.

Net income was $4.9 billion versus $4.7 billion for the same period a year ago, beating Wall Street expectations. The company said its “other bets” category — the moonshots — had revenue of $448 million. Shares of Alphabet were up more than 5 per cent in after-hours trading.

Google was notorious for its indifference to Wall Street. But Alphabet has been a model student, reining in its expenses, using $5 billion of its $73 billion cash hoard to repurchase company stock and, with this latest report, giving investors more insight into how Google’s core business is performing.

The new disclosures, combined with its more investor-friendly tone and, of course, continued strong growth in its advertising business, are the main reasons Alphabet stock has jumped 43 per cent from a year ago, putting it neck and neck with Apple as the most valuable company in the world.

In fact, many Alphabet investors are hoping that merely disclosing new information will give the stock price an extra lift. In a recent report, Mark Mahaney, an analyst at RBC Capital Markets, called segment reporting “the most identifiable near-term catalyst in Internet land,” which is to say that when companies give investors more information, it makes them more eager to buy in.

The benefit of segment reporting for Alphabet and other high-growth Internet companies is that when investors are allowed to take an unvarnished look at how profitable one side of the business is, it tends to make them more forgiving of losses elsewhere.

Or at least that was what happened with Amazon, which recently began separating its retail operations from the results of its highly profitable cloud computing business, and Netflix, which used segment reporting to show investors that while it might be losing money internationally, its North American streaming business is doing well.

Spencer, of T Rowe Price, which holds Alphabet shares, said he had been happy with Alphabet’s progress but wanted the company to give back more of its cash pile to investors. “I would like to see more developments in terms of capital return, but not this year,” he said. “Baby steps with this company.”

Intriguing science projects

Of course, the reality is that, in revenue terms, nothing about Alphabet’s business has changed. Google began 2015 as a giant advertising company connected to a collection of intriguing science projects. Alphabet ended the year as a collection of intriguing science projects connected to a highly profitable advertising business.

Advertising continues to account for the lion’s share of the company’s revenue, and search advertising is about three-quarters of total revenue, according to estimates by Mahaney. For now, most everything investors are excited about also has to do with advertising.

This includes YouTube, whose annual revenue is now estimated at somewhere from $4 billion to $8 billion, and the Google Play store, Google’s mobile app store, which takes a cut of app revenue but recently started selling in-store advertisements.

“For a company of this size to continue to be able to grow at 20 per cent a year — that’s pretty remarkable,” said Ben Schachter, an analyst at Macquarie Securities.

What about those other bets, like the self-driving car? Right now they are just big losses. For investors, then, this report was less about the future than it was about reassuring them that the old Google is continuing to grow quickly, and that other products like YouTube are going to pick up the growth when search advertising starts to mature.

If one of the moonshots should work out, then great. Cherry on top.