The Alphabet Opportunity: What Waymo, DeepMind, And Verily Could Be Worth To Google's Parent

20 mins

The Alphabet Opportunity: What Waymo, DeepMind, And Verily Could Be Worth To Google's Parent

Mentioned in story

The ABCs Of Alphabet

The number one, followed by 100 zeros: that's the meaning of the mathematical term "googol". Google's founders may have accidentally misspelled the word when choosing a name for their search engine, but their intention was clear: to convey the vast amount of web data their search engine could sift through, scrutinize, and submit to users as easy-to-understand search results.

While the company remains rooted in online search, it restructured itself in 2015 and chose a new name, Alphabet, to better reflect its developing identity as a technology conglomerate. Look past the complexity, however, and the company consists of just two key parts: one is the core business that houses all its different Google services, and the other’s a collection of high-risk, high-reward moonshot projects that Alphabet files under its “other bets” umbrella.

Alphabet isn’t just one of the world’s biggest companies: it’s currently the third-largest publicly listed business of any description. Its sheer size makes Alphabet a large component of various US stock market indexes – and if you’re invested in an exchange-traded fund (ETF) that tracks one of those indexes, you may well own a piece of the company without even knowing it. But ETFs aside, there’s the perennial question: should you invest in Alphabet? To answer that properly, we’ll need to break the firm down into those two key parts we mentioned...

Okay Google, tell me about Alphabet’s core business

Google represents over 99% of Alphabet’s total revenue. That’s not so surprising when you realize the division includes such popular products Search, YouTube, Maps, Gmail, Drive, Android OS, Chrome, and Pixel smartphones. Via these services, Google can develop a pretty clear picture of who you are and what makes you tick – and then uses that data to target you with advertisements. Every time a user sees or clicks one of those ads, Google gets paid. And just like social media platform Facebook (check out our Six Things You Need To Know About Facebook Pack for more on that front), advertising is Google’s main source of revenue. It’s driven by two key metrics:

  • Cost per click / impression (price)
  • Number of clicks / impressions (volume)

While Google has developed other sources of revenue in recent years – such as selling digital content (through Google Play), hardware (like phones and smart speakers), and cloud services (the G Suite) – advertising still represents the lion’s share. Google’s dominance of 90% of internet search helps it take roughly 30% of all global digital ad revenue each year, creating both a steady stream of cash and a moat against competitors. Consider the search suggestions that pop up before you’ve finished typing: Google’s algorithms improve a tiny bit each time a search is conducted, and with billions of searches conducted every day, websites fall over themselves to improve their Googleability.

But the fact that Google acts as many people’s gateway to the internet also brings about some challenges. Countries want a piece of its profit via tech tax schemes, politicians want to protect consumers, and regulators are slapping the company with hefty fines left and right for data privacy lapses.

Nevertheless, with a stock market value of almost $1 trillion, Google’s Alphabet parent remains an absolute giant. That’s great for those who invested back when it was tiny, but the question is: how much bigger can it get? To answer that, we’ll set Google aside for now and focus on three of Alphabet’s most promising moonshots. If just one of these can become a big, sustainable business in its own right, Alphabet will have not one but two giants – likely pushing up its stock price. So let’s get cracking.

The takeaway: Alphabet is a giant company made up of a core platform (Google) and a collection of high-risk, high-reward moonshot projects that could be key to future growth.

What's Waymo Worth?

Waymo is Google’s self-driving technology company, on a mission to develop fully autonomous vehicles (AVs). These could reduce road traffic accidents, offer mobility to those unable to drive, and provide a ride-hailing service without the need to pay any pesky human drivers – Waymo One is already live in Phoenix, Arizona, with Google hoping to shortly expand the service to other cities.

Sounds futuristic – so can Waymo succeed?

There are bumps in the road ahead. Any revolutionary new product coming to market will always be faster than the law – and that's true of self-driving cars, where regulation is still playing catch-up. The international Vienna Convention on Road Traffic, for example, has articles that can be interpreted as “a driver should always remain in control of a vehicle” – and further amendments are needed in those cases to make fully autonomous vehicles legal in countries such as Germany, France, Italy, and more.

Like Waymo One, the law is slow-moving, but it’s headed in the right direction – especially in the US. As more live operating data accrues over time and AVs rack up millions of miles with minimal accidents, regulators around the world should get more comfortable with the likes of Waymo on their roads.

But will consumers take to AVs? According to the American Automobile Association, 71% of people are worried about riding in an AV. Waymo is trying to tackle this through an education campaign, partnering with various autos groups to combat the confusion and fear around AVs. While greater familiarity should address that over time, the sector has a way to go yet.

And then there’s the competition. Companies from Uber to Cruise (owned by General Motors) are working on their own AV ride-hailing services, while Tesla and Mobileye (owned by Intel) are busy developing their own self-driving technology.

Waymo, however, has several advantages. Its cars have driven by far the most miles, and industry experts regard the company’s technology as the most advanced. So advanced, in fact, that Uber allegedly stole some of Waymo’s trade secrets and infringed on its patents. In the subsequent lawsuit, Uber settled by giving Waymo 0.34% of its shares and, kindly, agreeing to not pinch any intellectual property in the future.

self-driving

One extra advantage in Waymo's favor is funding. Alphabet’s core business, Google, is a cash cow the likes of Uber and Tesla could only dream of. Traditional car companies, meanwhile, have heavy manufacturing costs: if the economy sours (check out our Pack on The Next Recession), these firms could really start to hemorrhage cash. Just look at General Motors, which went bankrupt during the last financial crisis.

Waymo's big disadvantage, though, is scale. Uber already has millions of users riding around in its cars, which could enable the company to introduce AVs more selectively and intelligently – say, by drip-feeding AVs into lower-mileage, higher-drive-time areas to begin with.

Profitability is another challenge, as it is with any tech startup. Waymo has already brought down the cost of its technology by 90%, but its labor still represents a major expense given the need for back-up human safety drivers across its Waymo One service. In fact, the ongoing presence of these human back-ups led investment bank Morgan Stanley to slash its Waymo valuation by 40% in September 2019. Still, back in Waymo One’s hometown of Phoenix, the company recently got in touch with customers to let them know their next autonomous vehicle trip might finally be driver-free…

How much could Waymo be worth?

Let’s fast forward five years and assume Waymo arrives at its AV destination. How much revenue might it generate for Alphabet? Well, Waymo’s got two main potential revenue streams: ride-hailing and the sale of its tech to car manufacturers.

Goldman Sachs forecasts ride-hailers will cover 120 billion miles in 2024. Let’s assume Waymo captures just 10% of that, and generates $2 per mile (the current average cost per mile for a rider in an Uber or Lyft in the US is around $2.20). Waymo could probably price its service cheaper without the expense of human drivers. But it would also likely monetize its riders through onboard entertainment or location-based advertising.

Such a scenario would equate to $24 billion in annual revenue. Apply a “revenue multiple” of 4.5x (a slight premium to Uber’s current 4x, considering Waymo’s theoretically higher margins from a lower cost base), and you’ve got a valuation of $108 billion in five years’ time (or $67 billion discounted to 2019 at 10%).

But there’s more. Annual global car sales today are roughly 80 million. If Waymo sells its self-driving technology to just 1% of that addressable market, we’d be talking 0.8 million unit sales per year. Revenue per unit is harder to measure. In early 2017, Waymo said it had brought down the cost of producing its LIDAR technology to $7,500. With further cost declines it could sell this for $10,000 a unit and make a healthy profit. Multiply that price by 0.8 million unit sales and we’ve got another $8 billion in annual revenue.

Picking a multiple here is difficult, as there’s no pure AV technology company currently listed on any stock markets. The closest was Mobileye before it got bought by Intel. But seeing as Intel also sells its chips to the AV market, let’s take Intel’s revenue multiple of 3.5x for the sake of argument. Applying this to $8 billion of Waymo technology sales equates to a value of $28 billion five years from now (or $17 billion discounted to 2019 at 10%).

There are a lot of hypotheticals, it’s true. But combine these two numbers, and you come up with a potential Waymo valuation of $84 billion today. Compare that estimate to what the banks are saying: Morgan Stanley thinks Waymo’s worth $105 billion, while analysts at UBS put the number at anywhere between $25 billion and $135 billion. Tidy.

The takeaway: Waymo has plenty of rivers to cross, but it’s ahead of the competition – and could potentially be worth $84 billion right now.

DeepMind

DeepMind Technologies is a software company developing a “general purpose” artificial intelligence. That's an AI that can be used for a wide range of applications. The goal is to create software that can independently learn how to address any complex task, and to use those digital smarts to solve real-world problems. And UK-based DeepMind was – you guessed it – acquired by Alphabet in 2014 for $500 million.

Show me the money

DeepMind has so far struggled in its efforts to monetize its technology. A good start would be selling the use of its software to external parties – something DeepMind Health is doing with a number of British healthcare organizations. But DeepMind Health was transferred to Google in September, undermining DeepMind’s standalone value – and DeepMind’s cofounder followed in December.

DeepMind could potentially sell easily accessible standalone services using its technology, such as its advanced text-to-speech converter. Again, however, that's currently offered as part of Google Cloud – with any monetary benefits largely going to sister company Google.

In fact, Google is DeepMind’s biggest customer – not to mention its biggest source of revenue. DeepMind for Google is a dedicated division within DeepMind which embeds its AI technology into other Google products. It’s helped Google reduce the costs of cooling its data centers by 40%, made Google Assistant sound more human, optimized ads targeting, and personalized app recommendations in the Play Store – and then some.

If it’s to become profitable, however, DeepMind will have to find meaningful sources of revenue outside of Google. Staff costs doubled in 2018 to over $480 million, and while revenue also doubled to $125 million, the company’s losses soared to $570 million – an increase of over 50% compared to 2017. No one knows how long Alphabet will tolerate these annual losses before potentially absorbing the whole shebang into Google. Of course, Alphabet may also be actively preventing DeepMind from offering its services to other firms in order to keep a competitive edge…

AI is currently an extremely hot industry with no shortage of DeepMind competitors – from Microsoft’s Maluuba and OpenAI in the US to Baidu, Alibaba and Tencent in China. While it’s hard to say who, objectively, has the best talent and technology, you could argue that DeepMind has a better brand. It raked in publicity in 2017 after its specialist AlphaGo program beat the human world champion at the ancient Chinese strategy game Go. There’s even a feature-length documentary about the match.

Still, the intense competition DeepMind faces means the potential AI revenue pie will likely be shared among multiple players in the near term. And with other tech companies like Amazon, Apple, and Facebook battling to hire the world experts, it’s no wonder DeepMind’s biggest cost is its staff: do the math and you’ll find it paid an average compensation of $570,000 in 2018. Per head.

In October 2018, however, Google announced it had built a computer that was capable of “quantum supremacy”. That is, performing a complex calculation in 200 seconds that would take the fastest previous supercomputers 10,000 years. While this was quickly rebuffed by IBM in a (very) technical blog post, the key takeaway is that there’s an arms race going on among big tech companies right now. A quantum breakthrough would provide an, er, quantum leap in computer processing speed and power – and be a game-changer for AI. If Google really does get there first, DeepMind could leave its rivals in the dust.

How much could DeepMind be worth?

As with Waymo, the best we can do is to provide a framework for you to play around with your own assumptions.

DeepMind generated $125 million of revenue in 2018, with most of that coming from Google. While an impressive 115% annual growth rate, this was based on small potatoes. So let’s assume a more conservative compounded annual growth rate of 40% over the next few years – with revenue in 2024 sitting at $940 million.

How many other Big Tech customers could DeepMind sell its services to? Well, there’s the FAANGS: Facebook, Amazon, Apple, Netflix, and Google, who we've already accounted for. If DeepMind is far enough ahead of the game to tempt Google’s tech rivals to its services, $940 million from five large tech customers would total $4.7 billion. As we saw with DeepMind Health, however, the company can also sell its technology to other sectors – energy springs to mind. So let’s assume an additional 20% of revenue from sectors outside tech, giving us total 2024 revenue of $5.6 billion.

Because DeepMind sells its AI software to others, we can look at other ”software as a service” (SaaS) companies to figure out an appropriate revenue multiple. Four of the largest SaaS companies (Salesforce, Oracle, SAP, and Akamai) trade at an average revenue multiple of 6.1x. Applying this to $5.6 billion of DeepMind revenue equates to a valuation of $34 billion in five years’ time ($21 billion discounted to 2019 at 10%).

Keep in mind that, for now at least, DeepMind and Google are so intertwined that very few investors think of the former as its own company. Whenever DeepMind works with external parties, it gains access to valuable data that enhances its algorithms – remember your Google autofills? While this data remains the property of any outside organizations it comes from, the software that learns from that data will belong to Alphabet. And perhaps this is DeepMind’s biggest asset: it’s an incredible algorithm factory for use at Google and elsewhere…

The takeaway: DeepMind has a lot of potential, and if it can overcome its close relationship with Google to monetize its technology, it could be worth as much as $21 billion.

Verily

Verily is a life sciences company that busies itself inventing new technologies and services that could help people live healthier lives. By combining technology and data science with healthcare, the company – “spun off” from Alphabet research hothouse Google X in 2015 – does two main things: develop tools and devices to collect, organize, and interpret health data, and create ways to prevent and treat various diseases.

What exactly are we talking about?

Verily has a wide portfolio of products and projects, from “stabilizing utensils” (for people with tremors) to “study watches” (for continuous data collection in clinical studies). For now, a lot of its products are focused on one growing area: digital diabetes management. Those are the ones we’ll take a stab at summarizing here.

Working with eyecare specialist Alcon, Verily has created smart contact lenses with sensors and wireless functionality which monitor and transmit the glucose levels of patients with diabetes. But clinical trials have so far proved inconsistent, and Verily has put the project on hold until it figures out how to get more reliable blood sugar data from tears.

In the meantime, the company’s working on another device with a similar aim: a bandage-sized, cloud-connected wearable patch. The product is being developed in partnership with DexCom, an established player in the field, and represents another push to supersede the current finger-prick system of glucose monitoring.

The market potential for this product is huge: according to the World Health Organization, over 400 million adults globally live with diabetes, and those who use insulin therapy have to check their glucose levels four times a day. Continuous data, as opposed to infrequent snapshots, would provide valuable insights for people seeking to better manage their condition through more targeted treatment.

And Verily is bringing Alphabet’s expertise in data science to bear on the same problem in partnership with Sanofi, a large multinational pharmaceutical company. Together, they’ve created Onduo: a personalized diabetes management platform which combines devices, software, medicine, and professional care. What does this actually mean in practice? Improved medication management, intelligent habit-tracking and personal goals delivered through an app which also offers insights and advice. The Onduo platform is already being tested across multiple healthcare networks in the US.

In the UK, meanwhile, Verily is collaborating with the country’s National Health Service on an early intervention program that uses data analytics to identify patients at risk of chronic conditions like type 2 diabetes. The goal is to help healthcare providers better manage such conditions and reduce expensive unplanned hospitalization – improving both patient welfare and public health finances…

So how much could Verily be worth?

To answer that, let’s first look at the market potential of Verily’s key products. As we’ve seen already, the company is very focused on digital diabetes management: a relatively new market, but one with loads of growth potential. Annual growth forecasts from multiple studies and market research firms are in the 20-24% range, valuing the overall digital diabetes management market at around $25 billion by the middle of the next decade.

You can use your own assumptions, but let’s say that Verily can capture just 10% of that market, or $2.5 billion of annual revenue. We can again apply a revenue multiple by reference to a relevant firm. DexCom, Verily’s glucose-monitoring partner, focuses solely on digital diabetes management – and its shares trade at a 10.8x revenue multiple. Applying this to $2.5 billion of Verily revenue works out at a valuation of $27 billion in 2024 (or $17 billion discounted to 2019 at 10%).

The takeaway*:* Verily is trying to take a big bite out of the fast-growing digital diabetes management market – and if it succeeds, it could be worth $17 billion.

Putting It All Together

Remember, Alphabet is made up of a core advertising business – Google – and a collection of high-risk, high-reward moonshot projects. So to work out Alphabet’s total value, we’ll add together the values of the individual businesses.

Valuing Google

The golden Google is a cash cow: its dominance in digital advertising provides it with a steady stream of revenue and a strong competitive moat. This makes it a good candidate for valuation using a “discounted cash flow” model: forecasting Google’s future free cash flow (the amount of cash a business generates after all necessary reinvestments) and discounting that back to the present.

Feel free to make your own assumptions, of course, but we’re imagining Google’s historical 15% free cash flow growth rate between 2013 and 2018 continues next year, then slows to 3% by 2024. We’ve also assumed an 8% discount rate – lower than the 10% used for the moonshot projects to reflect the more established Google's lower risk – which gives us a present value of $767 billion (check out our Pack on How To Value Stocks to learn how to do these sums yourself). Adding Google’s cash reserves of $107 billion gives a total company valuation of $874 billion – not far off Alphabet's stock market value as of late November 2019.

The moonshots

If you agree with the above assumptions, then Alphabet's current valuation isn’t paying much heed to its moonshot projects – which, you’ll remember from the previous sessions, could be worth $84 million (Waymo), $21 billion (DeepMind), and $17 billion (Verily), assuming they succeed.

The beauty of a simple additive approach is flexibility. For example, let’s say you believe only Waymo and Verily will be successful. Then you can gauge Alphabet’s total value as Google ($874 billion) plus Waymo ($84 billion) and Verily ($17 billion). That'd equal $975 billion – above Alphabet’s current stock market capitalization, implying Alphabet shares could be a good buy.

You may instead want to risk-adjust the value of the moonshot projects based on the odds you give each of succeeding. For example, let’s say you think Waymo has a 50% chance of being successful, DeepMind 70% and Verily 90%. Then you can gauge Alphabet’s value as Google ($874 billion) plus 50% of Waymo (0.5 x $84 billion), 70% of DeepMind (0.7 x $21 billion), and 90% of Verily (0.9 x $17 billion) = $946 billion. Again, that’s above Alphabet’s current share price valuation – which would, again, make Alphabet a good buy.

What does Wall Street think Alphabet is worth?

At the time of publication, Alphabet has 38 buy ratings, 6 holds, and no sell recommendations from industry analysts . The average one-year price target among these experts is $1,453 per share – which would give Alphabet a total value of roughly $1 trillion. But what isn’t clear is how much of that growth analysts expect to come from Google, and how much they’re attributing to Alphabet’s moonshot projects. So far, very few analysts are explicitly giving them any value at all – and those that do only take into account Waymo.

One final thought before you rush out to buy Alphabet shares: the company trades on the US NASDAQ stock exchange under two names: GOOG and GOOGL. These two “tickers” represent two different classes of shares with two different levels of voting rights. GOOGL, the “class A" share, gives investors one vote per share. GOOG, by contrast, is a "class C" share with no votes. That leaves "class B" shares, which aren’t traded publicly. Those are owned by the company’s founders and a select few insiders, all of whom receive ten votes per share. And based on the latest data, those shares carry 61% of the total voting power at the company. So GOOGL or no GOOGL, it's probably best to limit your expectations of how much sway you'll actually have...

The takeaway: We can view Alphabet’s total value as the sum of Google and its moonshots based on how likely we think each will succeed, and compare it to Alphabet's current stock price to see if its shares are potentially undervalued.

In this Pack, you’ve learned:

🔹 Alphabet is a giant tech company made up of a core platform (Google) plus a collection of high-risk, high-reward moonshot projects. Many analysts, though, currently base its value on Google alone.

🔹 Self-driving vehicle project Waymo has some roadblocks to avoid, but it’s ahead of the competition and could be worth $84 billion.

🔹 AI project DeepMind has a lot of potential, but its close relationship with Google is complicating efforts to externally monetize its technology. If it can figure things out, it could be worth $21 billion.

🔹 Verily is trying to grab a share of the fast-growing digital diabetes management market – and if it can capture just 10% of that, it could be worth $17 billion.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG