Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

The Alphabet Money Machine, threatened by Trump?

Alphabet (NASDAQ: GOOG), the company formerly known as Google, is doing better than ever as it sails into troubled waters.

Alphabet (NASDAQ: GOOGL) is still demonstrating extraordinary moneymaking capabilities. The company reported $110.855 billion in annual revenues on 31 December 2017. That was up from $90.272 billion in annual revenues on 31 December 2016.

Alphabet also reported a gross profit of $65.272 billion, an operating income of $26.146 billion, and a net income of $12.662 billion for 2017. Interestingly enough, the net income and operating income were down from 2016. Google’s parent reported a net income of $19.478 billion and an operating income of $23.716 billion in December 2016.

Google is Doing More Business but Making Less Money

The logical inference from these numbers is that Google is doing more business but making less money. Another obvious conclusion is that Google’s expenses have increased.

The numbers verify that conclusion; Alphabet Inc. reported operating expenses of $31.418 billion for 2016, and $39.126 billion for 2017. Alphabet’s expenses grew by $7.978 billion in 2017. It is now costing Google more money to make money from its core businesses such as search and advertising.

This situation is bothersome because of the slow decline of some of Alphabet’s core businesses including search and advertising. Therefore it is a good time for investors to take a close look at some of Alphabet’s businesses.

Google Still Owns Search and Digital Advertising

Google’s position in search seems secure. Google Sites controlled 63.2% of the U.S. Search business in January 2018, down from 63.4% a year earlier in January 2017, Statista reported.

The only serious competition that Google Sites has in the USA, is Microsoft Sites (NASDAQ: MFT) which had 23.7% of the US market in January 2018. That was up by 1.1% from January 2017 when Microsoft Sites had 22.8% of the search market.

Google’s share of search is consistent and so its share of digital advertising. Alphabet had a 33% share of the worldwide digital advertising market in 2017, Statista estimated. That was up from 32.8% in 2016 and it is expected to remain consistent.

Statista predicted that Google’s would retain a 32.4% share of digital advertising in 2018; and a 32.3% share in 2019. To a value investor that means Alphabet will keep making piles of money from digital advertising for the foreseeable future.

How Trump’s Trade War Threatens Alphabet

The biggest current threat to Alphabet might be the trade war that U.S. President Donald J. Trump (R-New York) has declared against the European Union (EU).

The EU has placed tariffs on a variety of U.S. goods including Harley Davidson motorcycles in retaliation for 25% tariffs on steel and 10% duties on aluminum levied by Trump. The logical escalation of this will be for the European Commission to start targeting U.S. companies.

Since Alphabet is that the top of the EU’s wanted list it would presumably be first. The European Commission fined Alphabet $2.7 billion in June 2017, in an anti-trust case, Wired reported. The commission alleged that Google Shopping is a monopoly.

The next logical target would be the Google search engine which is the cornerstone of Alphabet’s business. If Alphabet were thrown out of Europe or forced to reduce its business on the continent it would be disastrous for the company. The EU has also gone after Alphabet for back taxes and labeled Alphabet a monopoly.

If Trump (who is already loathed by many Europeans) continues his trade war the EU can retaliate with an all-out offensive against large U.S. companies beginning with Alphabet. The worst case scenario would be that Alphabet was thrown out of the EU or forced to sell or spin off all or part of its European businesses.

One reason why the EU would target Alphabet is to pressure large U.S. companies to put political pressure on Trump. The 2018 U.S. congressional elections and the upcoming 2020 electoral season provide more impetus for such actions.

The Greatest Threat to Alphabet

The greatest long-term threat to Alphabet is all the competition it is receiving in advertising. Menaces there include social media such as Facebook’s (NASDAQ: FB) and its WhatsApp solution. WhatsApp had 1.5 billion users in December 2017, Statista calculated.

Also dangerous is China’s Tencent Holdings (HKG: 0700); which owns WeChat and QQ. WeChat with 980 million users and QQ with 843 users in January 2018, Statista reported.

Potential threats include Telegram, which is planning its own cryptocurrency, and a wide variety of blockchain based upstarts. Telegram had 180 million active users in December 2017; an 80 million increase over February 2016 when 100 million people used the platform, Statista reported. Telegram is planning a multibillion-dollar initial cryptocurrency offering (ICO) in an attempt to transform itself into a platform that can offer advertising and compete with Alphabet, Techcruch reported.

A major problem for Alphabet will be blockchain-delivered entertainment. The Tencent-backed Chinese gaming company Mob Arts is planning a blockchain based Pan Entertainment Platform called 777.Bingo. The current plan is to use the Ethereum blockchain to take cryptocurrency payment for games via 777.Bingo.

These threats are theoretical but they are out there. The biggest problem competitors like this pose for Alphabet is that they will force it to make major investments in research and development to keep up with them. Another problem is the creation of expensive new infrastructure to deal with the threats.

The bottom line is that Alphabet is still a good company and its stock value investment. The conclusion is that this company’s market share and revenues will decline, but it will remain a huge moneymaker for the foreseeable future.