Google’s Alphabet coup – and why it matters for investors and advertisers

Partners at Green Square, Corporate Finance Advisors to the media and marketing sector, cast their eyes over the latest industry deals and look ahead to the next tranche of acquisitions.

So, why all the fuss about Google rebranding itself as Alphabet? Why all the news coverage, and why the 5 per cent spike in the tech giant’s share price as soon as the rebrand was announced?

First of all, we have to remember this is Google we’re talking about, one of the world’s biggest tech and media companies, as well as one of the most admired and most scrutinised. It pretty much owns internet search (at least in the west) and hoovers up billions of advertising dollars every year.

Much to everyone’s surprise, on Monday night Google announced a restructuring by creating a new holding company called Alphabet. Sme observers have commented that the all-important web domain alphabet.com is already owned by BMW, which apparently does not want to sell (not that that bothers Google; it says it will use the bizarre but rather clever domain name abc.xyz). And whether or not there might be a trademark infringement – Google is of course involved with the auto industry with its driverless car prototypes – is one for the lawyers.

But although a surprise, this is something I think Google had to do. The company is famous for many things, but it’s best known for its hugely successful search engine, which was the company’s first and most important product. It also has Android, an operating system which is dominant in the all-important mobile space, and of course YouTube, the internet’s leading video hosting site.

But Google is fundamentally an engineering company – and engineers are tinkerers and inventors. Google has come up with a lot of interesting ideas, some of which may become mainstream, others of which are destined to remain curiosities, answers for which there was never, ever, a question.

Driverless carsm fall into the former category, drones for delivering parcels, possibly the latter. Its Nest smart thermostats are another good idea, especially as the much-typed internet of things becomes a reality.

But the problem that Google has is that while it makes a great deal of money, a lot of its activities are probably loss-making. So the search engine brings in billions through pay-per-click/view advertising (about $66bn last year), but I suspect Android and the Chrome browser bring in relatively little. YouTube generates money from advertising, of course, but you have to wonder if the vast bandwidth it hogs (even the most conservative estimates place this at around 12 petabytes – that’s 12 million gigabytes – a day), and power it consumes, eats away at any profit.

Very little else the company does makes any money, let alone profit. Of course innovation is vital to Google’s continued success (as it is for Apple, Facebook, Amazon and others), but it can’t go on letting investors wonder which bits of the increasingly diverse and sprawling company are making money and which are expensive shots in the dark.

The new name and company structure allow it to have its cake and eat it – co-founders and leaders Sergey Brin and Larry Page (along with chief financial officer Ruth Porat) say it effectively simplifies the company, while at the same time maintaining its experimental animus and diversity; and it reassures shareholders while also allowing it to carry on following crazy hunches.

So, under the Alphabet banner we’ll have Google, helmed by rising star Sundar Pichai, and including search, advertising, maps, apps, Chrome, Android and YouTube; smart appliance unit Nest; investment arm Google Capital; venture capital investment vehicle Google Ventures; internet infrastructure unit Fiber; Robotics; Calico, a project to increase human longevity; Sidewalk Labs, an urban improvement programme; and Google X, the bit that does the crazy, creative stuff (in the trade, 'moonshots'), which may or may not make money, but are essential for the company’s self-image as an innovator and vital if it is to continue to attract the world’s best brains. Such ventures would include the famous driverless cars, the ill-starred Google Glass, delivery balloons and more.

Investors will be able to see how well the bit they’re most interested in – Google – is doing, and hopefully be reassured, while the splendidly named Astro Teller over at Google X will have the pressure taken off his ideas factory.

I think there’s one overriding reason why Google’s restructure makes sense and is super-smart, and that is because while it’s always good to have a strong core business, it’s never a good idea to be over-reliant on it. All the strong tech companies have diversified and benefited from that. Apple makes consumer devices and is a music retailer, rather than just being a computer maker; Amazon is no longer solely a retailer – it also creates and distributes content, offers cloud storage and web services; Facebook has virtual reality company and gamers’ favourite Oculus Rift, and its acquisitions WhatsApp and Instagram make it far more money than its social network. Even the once-derided Yahoo is making an effort to reinvent itself.

Contrast the fortunes of these behemoths with those of Microsoft, which, some analysts say, has been far too reliant far too long on its core operating system and software business, and whose attempts at diversification – buying Skype, Nokia – have not always been successful. Disgruntled ex-MSers have also claimed that the company’s bureaucratic structure and internal politics stifle innovation, something a company like Google/Alphabet would be keen to avoid.

Some observers, particularly in the US, have wondered whether the new, more transparent Alphabet structure will stifle innovation - the impact of the company’s unprofitable ventures on its overall bottom line will become more evident and could lead to those divisions being sold or shut down, thereby enhancing returns for demanding shareholders.

I don’t agree – I think the effect will be the opposite: innovation will be encouraged. Over the past 17 years or so Google has become synonymous with technological experiments, such as internet-delivery balloons, cancer detection pills, drones, and robotics, as well as search and advertising. Innovation is part of its very DNA.

While creativity might be a problem for certain investors, who invest primarily in its current suite of products and only tangentially in possible future products – many of which might never take off – others invest because the returns could be sky high and mitigate any risks. Stifle the spirit of innovation and the company will collapse.

It’s rather like the purchase a fortnight ago by Nikkei of The Financial Times. Some have fretted that the Pink ‘Un’s editorial independence will be compromised. If it were, or was ever called into question, there’s no reason anyone would buy it.

If the Nikkei company (often criticised for going soft on Japanese corporate culture) tries to stifle the strong journalistic values built up by the FT over the past 125 years, then it will have wasted the £845m it spent buying the venerable newspaper. Just as I can’t imagine Nikkei chairman Tsuneo Kita wanting to waste the better part of a billion dollars on trying to fix something that ain’t broke; nor can I see anyone but the most crazily cautions Alphabet investor trying to kill the golden egg-laying goose.

Whatever happens, things in the tech sector won’t be the same after the events of Monday night/Tuesday morning…

Barry Dudley is a partner at Green Square, corporate finance advisors to the media and marketing sector

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