WHAT HAS CHANGED?

Alphabet Q3 revenues were ahead of consensus, while EPS came in below consensus. The highlights this quarter include:

-Google's claim to quantum supremacy. Quantum supremacy refers to the ability of a quantum computer to perform computations that traditional computers cannot. -While paid clicks grew 18% y-o-y (below estimates of 32%), the cost per click declined 2% y-o-y (much ahead of the -12% consensus expectation). -While Google Cloud, Fiber and Verily drive revenues, costs were impacted by a one time charge of $554 mn related to the French legal costs. -For Q4, the management expects Fx to negatively impact financials.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are key drivers of Alphabet's value that present opportunities for upside or downside to the current Trefis price estimate for Alphabet:

Alphabet's Google Search Ads

• Google Search Ads Revenues: Google continues to lead the search market with an estimated market share of over 90% in 2018. As the company improves its in-app search with deep links, Google revenues from mobile search will improve. We currently project search ads revenues to grow to $209 billion by 2024.


• Google Search EBITDA Margin for desktop and mobile: We currently forecast Google's PC Search EBITDA margin to decline from 2018 level of 43.4% to 41.2% by the end of the Trefis forecast period. Historically, Google's main operating cost component has been traffic acquisition costs (TAC). We believe that investments to allay privacy related concerns, growth rate of TAC and employee compensation relative to revenues are likely to pressure its margins.

For additional details, select a driver above or select a division from the interactive Trefis split for Google at the top of the page.

BUSINESS SUMMARY

Google.com and Google's international sites (e.g. Google.ru, Google.com.br, and others) offer a dedicated platform to conduct searches on the Internet through PCs and wireless devices.

Google makes money from contextual advertising known as keyword advertising that is shown based on the type of search a user conducts. For example, a user searching for "NYC restaurants" would be shown a variety of ads on the right-hand side of Google's search results pertaining to restaurants and food services in New York City.

Advertisers on Google bid for keywords (such as "NYC restaurants ") to display their advertisements on the Google search page. Google AdWords allows these advertisers to display advertisements in Google's search results and the Google Content Network through either a cost-per-click or cost-per-view scheme. The pricing of keywords, the inventory of keywords available, and the frequency of user search, impact how much money Google makes on search.

In addition to advertising on its search engine, Alphabet makes money by placing advertisements on other Google-owned properties such as video sharing site YouTube, email service Google Mail (Gmail), etc. Alphabet also makes money by facilitating the placement of advertising on its "partner" websites (via ad serving platform AdSense) from which it receives a share of the advertising revenue.

Google search on mobile is increasingly gaining importance as more and more users are shifting towards mobile devices like smartphones and tablets for desktop-based web browsing. According to our estimates, derived from publicly available sources, tablets and smartphones surpassed PC's in use globally in 2014. As a result, mobile search is increasingly gaining importance for Google, rivaling its PC-based search in contributing towards Google's stock.

SOURCES OF VALUE

We believe Google Search Ads is much more valuable than Ad Partnerships for Search & Content, YouTube, Gmail and other divisions of Alphabet due to the following reasons:

Google Dominates Web Search on a Global Scale

Alphabet's flagship search business, Google, continues to dominate globally. Competitors such as Microsoft have been consistently pushed back as Google retains market shares of around 63% and 95% in PC and mobile devices respectively. The company's superior algorithms and brand recognition have clearly found favor with users, and to date the search engine market has not boasted of a better search tool. Given the current trends, Google's dominance is expected to continue, although one cannot discount future technologies such as Apple's Siri as possible future threats.

Growing Internet Searches per PC in Use

As web penetration increases across emerging markets like India, users are expected to increasingly become more familiar and comfortable with using web search as the flagship tool to look for information. In addition to this, web browser development has increasingly made it easier to promptly do a web search. For example, Google Chrome obviates the need to actually open the Google homepage to do a search. These above factors should contribute significantly in growing web searches for every PC device globally.

Smartphone and Tablet Usage on the Rise

The mobile revolution would have a big role to play in the way Google search is utilized. Smartphone and tablet capabilities are improving by leaps and bounds. This includes personal usage like finding restaurants and utilizing maps and GPS (Global Positioning System), as well as professional uses such as sending/receiving e-mails and making presentations. As bandwidths increase in emerging markets, mobile device functionality is expected to come at par with PCs in the coming years. This should lead to a substantial increase in the number of mobile devices in use globally.

KEY TRENDS

Growing Mobile Search

We expect increasing adoption of Internet search capable mobile phones, higher mobile Internet speeds, and increasing partnerships between search engines and mobile phone manufacturers (for e.g. think Google search on iPhone). According to a report by Zion Research, global mobile ad spending is expected to grow to $245 billion by 2022, a CAGR 15% over 2016 numbers. Google's open source mobile OS, the Android, should greatly benefit from this, as it uses Google search as the default search option. The Android also has the advantage of being used by multiple manufacturers, including Samsung, LG HTC and most of the Chinese vendors.

Increasing Video Advertising

In contrast to search, which is more functional and commercial in nature, online video and social networking are more entertainment-focused, where ads are generally seen as a distraction. Currently, ads displayed on such platforms are graphical and static in nature, which does not drive the same recall as a moving video (e.g. television ads). As YouTube and other video sharing sites figure out better ways of displaying ads which are not intrusive and do not interfere much with the user experience, advertisers will be willing to pay more for such ads, driving up overall video advertising monetization.

In-App search Can Be A Challenge

With the advent of the smartphone, application development has taken center stage. Most smartphone users now use specific apps to search for products and services. For example, users tend to use Amazon's app to search for products they want to buy, and Yelp's app to search for services (Resturant, Taxi's etc). As a result, Google's search engine is circumvented completely. This can lead to a loss in revenues and market share for the company. However, to get around this issue, Google introduced deep links that surface information stored in apps. This has helped the company to counter the effects of in-app search, and the mobile revenues for the company have improved.

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