Google 2024 Outlook: Antitrust Risks Still Greater Than Strong Q4 (NASDAQ:GOOG)

investment thesis

Despite Alphabet Inc. life Google (NASDAQ:GOOGL) (NASDAQ:GOOG) Despite posting a solid fourth quarter (excluding a slight loss in advertising revenue), I still believe the search giant is in for a strong sell-off. that much Granted, the company’s operating performance has been quite strong recently. earnings reportUnfortunately, it doesn’t alleviate my underlying concerns.

In particular, after its third quarter results, Google continues to underperform the S&P 500 (SP500). The upcoming antitrust case launched by the U.S. Department of Justice is still very real and introduces a layer of uncertainty. The company’s legal setback against Epic Games (which I don’t think gets enough attention) may be indicative of a broader pattern of legal vulnerabilities.

I think the stock is a sell. The legal risks here can be high; Impact on business model. These implications are more important than the operational strength of the fourth quarter.

Background: Performance is good, concerns remain

Google’s parent company, Alphabet, ended 2023 with strong financial performance. In the fourth quarter, the company reported an impressive $86.31 billion in revenue, up 13% year-over-year. This growth is largely supported by the strength of Google Cloud and the strength of its services across key areas such as still-strong advertising revenue, search, and YouTube (more on this below and why you’re seeing these revenues).

The strong revenues so far have allayed concerns (myself included) that Google Search would be hurt by increased competition from the likes of ChatGPT and Microsoft Bing. Google’s bear case).

However, I still believe that this solid financial foundation and technological advancements are overshadowed by ongoing antitrust concerns. The main case (the US Justice Department case that began in 2023) is likely to conclude arguments in May of this year (see details below).

Q4 Earnings Summary: Mixed Signals and Costly Strategic Shifts

For the bulls, fourth quarter earnings showed strong profit metrics. Alphabet beat Wall Street revenue and EPS estimates, reporting $86.31 billion in revenue and $1.64 EPS. The real downside to the quarter was Alphabet’s total advertising revenue, which totaled $65.5 billion, compared to analysts’ expectations of $66 billion.

The key to this advertising revenue is that Google has powerful algorithms that help match your ads to the best users on YouTube, Google Search, and more. The platform has not yet been shut down by the pending antitrust lawsuit, but it is at the heart of the lawsuit. What impact will this have on future advertising business models if ad sales fall short of expectations even before lawsuits disrupt ad placement algorithms?

As the bottom line earnings note (among other things), efforts to keep pace with the AI ​​race are straining Alphabet’s resources. The company experienced a significant cash decline, with its cash position falling by approximately $10 billion from the previous quarter to its lowest level since fiscal 2018. This was compounded by a significant jump in CapEx in the fourth quarter to $11 billion, primarily due to investments in technology infrastructure. Ambitious AI initiative​​.

Antitrust: Why This Is Still the Elephant in the Room (After Q4 Earnings)

I am currently working on United States v. We believe the Google LLC lawsuit is an important case that will not only shape the company’s trajectory, but also potentially set a new precedent in antitrust law.

Last year, the Justice Department accused Google of monopolizing the digital advertising technology market, an accusation the company strongly denied. The lawsuit, which began in January 2023, has garnered growing support, with 18 states joining the suit, signaling bipartisan concerns about Google’s marketplace practices.​​​​

At the heart of the trial is whether Google’s dominance and business practices, particularly its basic search agreements with major technology companies like Apple, constitute an illegal monopoly. These agreements are alleged to stifle competition by making Google the default search engine across a variety of devices and platforms. Critics argue that while this move solidifies Google’s market dominance, it also helps supply Google’s core ad serving engine (as mentioned earlier). Google’s dominance is reflected in its search market share, which has consistently hovered between 83% and 91% since 2015. This agreement has been instrumental in helping Google continue to improve its search products through data accumulation.

The court’s decision, expected after final arguments (scheduled for May 2024), will be a milestone that will determine the future of antitrust law and the future of Alphabet.

Why This Matters (Earnings Report Update)

As Alphabet CEO Sundar Pichai noted during the company’s fourth-quarter earnings call, the quality of its advertising services is essential to the success of Google’s search advertising business. This quality is built in part on the search deals Google has with browser providers like Apple’s Safari.

Our work has been driven by tremendous confidence in quality – search quality, ad quality, improved search, improved ad RPM. Our two guiding principles are a special focus on ad quality to deliver real ROI to advertisers. We improve the user and all user experiences through rigor and technical excellence. – Pichai 2023 fourth quarter earnings announcement.

Essentially, investors (and executives) have known about the antitrust risks for over a year, but (via Pichai’s comments) it appears that their core advertising revenue model still relies on this disputed technology. Here, the company’s ‘technical excellence’, which he praises, is in danger. I am concerned that he is pushing this as a strength of his business.

Legal precedent is a headwind here

Precedents (which are important in court cases) do not help the search giant. Google recently lost a court case over anti-competitive concerns about the Google Play Store and whether game developers (in this case, Epic Games) have the right not to have to pay revenue-sharing agreements to Google. In other words, it was ruled that a platform owned by Google (Google Play Store) had monopolistic practices, and the court ordered Google to allow others to use the venue and not pay Google any revenue sharing installments. . Google’s AdWords (now called Google Ads) could meet a similar fate.

My Valuation Problem: Premium Price?

At this point, we believe it will be difficult to accurately quantify the impact a negative antitrust ruling will have on our bottom line. However, I believe every investor should have some margin of safety before entering stocks.

In this case, Alphabet’s forward P/E ratio is still 20.95 times forward earnings for the next 12 months. Although this P/E ratio is lower than last December’s strong sell thesis (forward P/E of 23.09 at the time), this forward P/E ratio is still higher than the sector average of 36.13%.

In fact, compared to December, the search giant’s P/E ratio is well ahead of the industry average in December (33% higher in December and now 36.13% higher).

Why should a company that missed the last search ad revenue revenue estimate, combined with strong legal risks exacerbated by its losses to Epic Games since December, be higher than its segment premium multiple?

In my opinion, the stock should trade at a sector-average P/E ratio until investors can be confident that the company’s business model will be strong with or without synergies from Google’s larger ecosystem.

If the stock were to be revalued at its sector average forward P/E of 15.39 (compared to the current 20.95), this would represent a 26.54% downside for the company’s stock.

Bull Thesis: (What am I missing?)

Even amid challenges from antitrust litigation, Alphabet Inc. (Google’s parent company) continues to demonstrate strong profitability that could potentially cushion the impact of regulatory headwinds. The company’s continued investment in AI could help diversify its revenue in the long run, but this is yet to be proven. As I wrote in December, the leading large-scale language model, LLM (Gemini), still lags behind GPT4 via Microsoft/OpenAI. There’s no guarantee they’ll be able to catch up (and thereby diversify their business model away from advertising sales, which faces antitrust risk).

Meanwhile, AI investment spending here continues to surge, according to the fourth quarter capex memo. Google could accelerate development by going down the open source route like its Meta Platform (META), or focus on model fine-tuning and training like IBM (IBM) and worry less about its own LLM. However, management did not take this approach. This means that its business model continues to face concentrated revenue risk from litigation.

conclusion

While Alphabet’s strong performance and strategic investments in AI demonstrate the search giant’s desire for change, its recent mixed financial signals (missing ad sales) and an overshadowed antitrust trial present serious challenges. We believe the outcome of the antitrust case and its impact on Alphabet’s business model is very important and requires extreme caution when investing. There are numerous opportunities for investors to capitalize on the explosion in demand for AI from businesses and consumers. In this field, I tend to believe that powerful innovation must come at a price (hence the investment framework GARP). I think Google stock is a sell at this point.