New Alphabet For Google

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Alphabet

The current CEO of Google (NASDAQ:GOOG), Larry Page, announced on Monday that the board has decided to form a new umbrella company called Alphabet, which would be a holding company for all the existing units within Google. [1] This move will enable the company to separate its businesses into separate entities within the holding company, as follows. First are the emerging ventures – or “moonshots” as they are known — ones that might provide high growth in the future but are investment intensive at present.  Included here are Google Drive, the broadband initiative and Google’s longevity, life sciences and other businesses. Then, there is the core Google within this holding company structure, which will include the familiar online search, ads, maps, the Google Play Store, YouTube, and Android — in a few words, the cash cows of the company. While the unit core Google will be headed by Sundar Pichai, the incubator companies will have its own CEO and existing executive management (Charin Eric Schmidt, CEO Larry Page, President Sergey Brin, and CFO Ruth Porat will comprise the top tier beneath the board.

Alphabet Inc. will replace Google Inc. as the publicly-traded entity and all shares of Google will automatically convert into the same number of shares of Alphabet, with all of the same rights. Google will become a wholly-owned subsidiary of Alphabet. The two classes of shares will continue to trade on Nasdaq as GOOGL and GOOG. We believe that this will increase transparency and make it easier to value the company. In this note, we discuss the benefit from this reorganization.

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Transparency in Business

Over the past few years, Google has been systematically investing in disparate businesses that it perceives to have high growth potential. However, most of these bets entail a high investment outlay, which weighs on the margins of the cash producing business — i.e., online search and ads business. By re-organizing each project into a separate unit with a CEO, the company plans to attach responsibility on each division. This will also help Wall-Street to ascertain whether these units are achieving their respective milestone. Thus it will become easier to value the core business (online ads and search) that is producing most of the cash for Google. For example in the first half of 2015, the ads division contributed over 90% to the topline i.e. $28.49 billion. However, the company invested close to $1.4 billion in non-marketable securities (including $998 million investment in SpaceX) and over $5.4 billion in capex (some of it related to acquisition of information technology related assets). This opacity can be solved by the announced reorganization. Moreover, it will allow the founders to fully focus on the full range of their initiatives as the core business continues under the effective management of Sundar Pichai.

We currently have a $657 price estimate for Google, which is 5% above the current market price.

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Notes:
  1. G is for Google, August 10 2015 []