Chit Chat Stocks - Why We Own Alphabet/Google (Ticker: GOOG)

Episode Date: February 7, 2023

This is our monthly Arch Capital episode. About once a month we will publish an episode that covers a company in the Arch Capital Investors Fund. These episodes will be modeled after our Not So Deep Dive episodes and will also be available on YouTube. Google (listed under its parent company: Alphabet) provides various products and platforms around the world. It is likely that you use Google products every day. These services include ads, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube. Brett and Ryan dive through Google and outline the investment thesis for why we own the company in our Arch Capital limited partnership. ****************************** What is Arch Capital? Arch Capital is a concentrated, long-only equity fund aiming to compound capital at an above-market rate. Arch managers are perpetual learners with a long-term focus that strive to build wealth with our partners through intelligent capital allocation. Learn more here: https://www.archcapitalfund.com/ ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Timestamps Company Background | (3:32) AI & ChatGPT | (23:20) Competitive Landscape | (31:38) YouTube | (41:55) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. Today is our monthly Arch Capital episode, where we analyze one stock we own in our

limited partnership that is called Arch Capital or the Arch Capital Limited Partnership. After of listening to this episode. We hope you get a better perspective on why we own the stock, the major risks, and what we'll be watching going forward. If you are interested in learning more about the fund, search Arch Capital online or Google Bing, or click the link in our show notes that'll take you directly to the website where you can learn more about it. Ryan, anything to add there? ArchCapitalFund.com because or else you're going to get some weird, I think like carpeting business. So no, archcapitalfund.com. That is the URL. Yep. And if you have any questions, just DM us on Twitter, email us at the email in the show notes, all that good stuff.

Today, we are going to be covering a little known company called Alphabet, otherwise known as Google, and a company that also owns YouTube, Google Cloud, and a few other things. But before we get to this episode, we have a few housekeeping items. If you are a regular listener to our Not So Deep Dive episodes or these Arch Capital episodes, basically the ones we do on Tuesday where we are analyzing stocks, you should subscribe to our free newsletter and get our show notes and charts with each episode. Within this one, we're going to be doing some valuation work that is a bit more extensive just because we're kind of going through the numbers we're looking at when covering Alphabet. And it's nice if you're listening or watching this

to get those numbers because we might not say all of them. We might not talk about all of them because it's very hard in an audio format to just list numbers off all the way. If you have that newsletter, it can be a great supplement to see how we're thinking. Also, if you like watching these, you can do so on YouTube or Spotify. We're going to be sharing our screen a bit with these. So those are the two platforms that are best. And if you enjoy the show, give us a review on Spotify or Apple Podcast. Today's episode is presented by Stratosphere, the best web-based research terminal for company specific metrics like KPIs and segment revenues. Stratosphere has clean data for KPIs, segment data that is triple checked for accuracy and beautiful data

visualizations helping save you time and frustration digging through SEC filings. We use Stratosphere as our investing home screen. We used it to research this episode, and we're going to be using some charts from them today. And you can too for free by going to stratosphere.io. That is stratosphere.io and get a discount on any of their paid plans by using our promo code CCM to get 15% off. All right, let's get into it. These are the ones where we ask questions to each other, but the first one is directed to me. So I'm going to ask myself, what is Alphabet? Alphabet is an internet giant with many, many different subsidiaries. The most important being Google. Search is within that, but it's also all the other Google properties.

So you have Search, Maps, Gmail. What am I missing here? Google Translate. A lot of products, but the main one that makes the most money is Google Search. Second company that they own is YouTube, which as many of you know, who may be watching on that right now, is the largest do-it-yourself video service in the world. Plus with other things like YouTube TV, YouTube Premium, YouTube Music, YouTube Primetime channels. Ryan is going to get to that when he covers the YouTube section. They also have Android. If anyone didn't know that, I know a lot of people will know that, but some people, you might not. They don't really talk about it that much, which is one of the two largest operating systems for smartphones. They also own Google Cloud, which is one of the three

big cloud infrastructure providers. Customers there include PayPal, Spotify, Home Depot, and others. The other competitors there would be Amazon Web Services and Microsoft Azure. Google Cloud has approximately 10% market share. We will be covering them in depth later in the episode. Next one, these are some smaller ones. We have Waymo, which is a self-driving car startup. Not really revenue material for Alphabet at the moment. There's also Verily, which is a bioscience startup.

There is Fitbit plus Nest Hardware Systems plus, I guess, I forgot to include here, the Pixel phone system that they have just started out and they're making hardware now. And then lastly, there is DeepMind, which is the world's premier AI research institution. Google slash Alphabet owns that as one of their subsidiaries. And for example, they were the ones that solved a huge protein folding problem for the biosciences market through their AI tools. I guess we'll call them that. Tools might be a little bit lame for something so cool as that. And just as important notes before we get into it, we're not going to talk too much about management today, but Alphabet is not currently run by its founders, who are Larry Page and Sergey Brin. If you're interested in those, there's Google Histories talked about constantly. There are tons of them on the internet. Today, though, it is run by Sundar Pichai, a CEO since 2019,

and who has been with the company since 2004. So he's a longtime Googler. And then the CFO, Chief Financial Officer is Ruth Porat, who joined in 2015, who's important one we'll talk about later in the capital allocation segment with the valuation. Okay, Ryan, before we get into the analysis, we always want for anyone learning about these companies to kind of know any sort of context. So for the listeners, give any important history and context for the Alphabet that business. Sure. So I guess a lot of people have probably heard this kind of founding story, but I'm going to go through it anyways, because I think it's kind of fascinating and it explains why they were so successful early on. So in 1997, Larry Page and Sergey Brin were both in the

process of getting their computer science PhDs at Stanford. And while they were there, they developed a search engine. I believe this was as a research project and it was initially called Backrub. I would say good name change. It wasn't the first web search engine. There were a lot out there, but it did have a slightly different architecture. So at the time, big search engines like Yahoo, their primary objectives were to keep people on their site as long as they could because they sold display ads. That's really how they made money. However, Google or Backrub at the time came along with a different way of determining page relevance. Yahoo would determine page relevance basically by keyword search, essentially. How many times does a keyword show up on a page? They'd rank that pretty highly in the search results. but there was a lot of keyword. I've heard people describe it as keyword stuffing. So people would

just throw keywords into pages and it would be kind of a waste. It wasn't the most useful article or search result that you could have found. And so Google kind of came along with this different architecture to determine page relevance, which was, I think it was called the page rank algorithm, which was how many times a page was referenced by another page. And then And there was, in particular, sort of an amplifier effect if it was referenced by a more important page, something that's kind of more well-regarded. And this reference links or this kind of sourcing from other pages led to more relevant search results when people would query something on Google search. And so it began to take off. And Google is really, really averse to trying to run ads.

They wanted to avoid it kind of as much as possible. They want it to be different. I think their slogan in the early days was don't be evil. That was kind of like their company motto. And it wasn't really until they saw someone else do it, I think his name was Bill Gross, with whatever company he had, that they started to implement the Google keywords advertising. And so the reason that they felt like this was maybe more noble, I guess you could call it, or more merit-based and more helpful to the actual platform overall, is it was a cost-per-click model. So as opposed to a CPM, where you're just paying to get brand advertising or display ads on a certain page, Google was really performance ads. How many times was the link clicked? It was very easy to track. And this grew really quickly. They found extraordinary adoption. So I read the S-1 or parts of the S-1 this morning. And let me just go through some of the numbers they filed just before going public in 2004. So in 1999, Google reported $220,000 in revenue. Yes, you heard that correctly, $220,000 in 1999. A year later, 2000, 19 million revenue. In 2001, 86 million in revenue. In 2002, 348 million in revenue. And they were doing this at a 53% operating margin when they were about to go public. um in 2003 so remember 2002 348 million in 2003 962 million it's almost a billion dollars in

revenue in 2003 at a 36 operating margin they started to invest more they it's it is the fastest growth i've ever seen prior to and profitable growth i've ever seen prior to uh an IPO or on NES1 at all. So just truly remarkable adoption, just incredible product market fit. And it is a testament to how different Google was at the time. During their IPO, they raised about $2 billion. It was pretty steep valuation. And it's interesting that they were able to raise this much money after the dot-com bubble. I can only imagine how much they would have been able to raise Doreen. But with the $2 billion that they raised and some additional cash flow that they generated from the business and then some stock, they made a series of acquisitions that

have completely shaped the company and probably, I would say, the best three acquisitions that a single company has made in its history. So in 2005, Google acquired a floundering mobile phone business called Android. It wasn't necessarily floundering, but it was struggling. It was starved for cash for $50 million. So they bought Android for $50 million. In 2006, a year later, they acquired YouTube for $1.65 billion in an all-stock deal. At the time, people thought Google was ridiculous for paying that much. And then in 2007, in an all-cash deal, Google paid $3.1 billion for a digital advertising company known as DoubleClick. DoubleClick gave Google their entrance into the display advertising market

because they really didn't have the technology for it. They were still relying on keywords at the time. And the reason that they were able to basically take DoubleClick and turn it into the behemoth that it's become is because Google had all the data on where the users would go next. And so they were able to actually track those users and say, even though it's brand advertising where you're running an ad on a display on a website, you know, okay, three clicks later, he looked up Coca-Cola and they were able to provide a tremendous value to businesses for that reason. Those acquisitions have all really helped accelerate Google's top line, but they've also really deepened its competitive advantage. And we're going to talk briefly about that in a

little bit. And then in terms of other important moments in its history, 2015 was when they announced this structural reorg where they changed the name to Alphabet. At this time, Sundar Pichai became the CEO of Google, while Larry Page and Sergey Brin became the top guys at Alphabet, the parent company. And they actually remained there until 2019 when they finally stepped down. Today, they both still remain on the board of directors and combined, they own 51% of the voting power. I find it interesting that it's 51%. So the two of them combined can really, if they both vote the same way, they control the company still no matter what. So pretty impressive, I guess, history, probably one of the most impressive corporate histories or

financially of any business we've ever looked at. Do you want to kind of go through the segments today and maybe some of the sub segments as well and talk about what's the most relevant and I guess the holistic product suite that Google has? Yeah. And just for reference for anyone that doesn't know, Google is approaching or Alphabet slash Google, we might interchange it here, is approaching $300 billion in revenue. I think I just looked it up. They're at about $282 billion in 2022. Either way, say right around $300 billion in less than 25 years from a standing start. Pretty darn good. But yeah, let's go through the segments. If you're looking at their investor press releases and stuff like that, they've divided this stuff into

segments that you have to really look at their definitions in the SEC filings to know what's exactly included. And I kind of change it into our own sub-segments that I think make sense from an investor perspective. So the first one is their Google search and other advertising. So this would include advertising on search, advertising on maps, advertising on Gmail, and advertising on Google Play. And that was 56% of revenue last quarter, so Q4 2022. Second category would be YouTube advertising, which they break out themselves. That is self-explanatory. And that was 10.5% of revenue last quarter. And then the third one will be Google network advertising. And these are the display advertisements that Ryan was talking

about on websites through AdSense and AdMob. And that is 11.1% of revenue last quarter. So even though they made that giant double-click acquisition, on its own, it's only turned into... I mean, it's been a great acquisition, right? But it's only turned into, say, 11% of the business Today, the search business is much more profitable on that cost per click versus those display ads, which I guess you can click on, but are a little more, I guess, less effective than the core search advertisements, but they do reinforce the search business. So as we'll talk about, a lot of the moves that Alphabet has made and why we feel confident in the moat today has been to strengthen the search moat and the search business through these acquisitions that also have their own business models themselves. Okay, there's two more here, or actually three more that are relevant. There's Google Other. This includes non-advertising revenue on Google Play. So say the take rate they earn from developers, non-advertising YouTube services. So this would be, say, YouTube TV, the primetime TV channels, or the YouTube premium, YouTube music stuff. this also includes in the google other hardware devices and something they include as other in the other segment so whatever is included there who knows but really this is google play take

rates non-advertising youtube and then hardware and that was 11 of revenue last quarter fifth one we have here is google cloud which are infrastructure services and google workspace subscriptions but mainly that infrastructure service um that they have and google workspaces say Google Drive mainly, which we're actually using right now. And then if we look at that as a percentage of revenue, it was 9.6% of revenue last quarter. And then lastly, they have other bets, which are internet services like Google Fiber, healthcare services through Verily and something else. They have another division there, autonomous vehicles, DeepMind, and that is only 0.3% of revenue. So these are all their research projects that we might talk

about as being a little thorn in the side of their profitability. But those are the ones that are more research projects that could be businesses someday, but not right now. I want to share my screen and show a good chart to outline how all of the other segments besides search are a similar portion of the company's revenue today. If we look at Google Cloud, YouTube ads, and Google Other, and then we're forgetting one here, but there's also Google Network, which I should add on here is kind of the same. They're at about, if we look at the trailing 12 months,

closing in on in between $25 billion and $30 billion in revenue. And these three, especially, I guess the reason I didn't include Google Networks is because we don't really have much of a thesis on that one for how that can grow.

But we'll talk about each three of these today, Google Cloud, YouTube Ads, and then Google Other, how they can maybe double their revenue or have a trajectory to possibly, you know, it's not guaranteed that all three of them will get there and get to $100 billion

revenue businesses someday. But all three of them are about 10% of Alphabet's total revenue as of this writing. Anything else there, Ryan, before we move on? No. Maybe addressing how Android is split.

Okay, so Android is in... It'll be in Google Other. They get any fees on that, but I'll talk about later in the episode how android works now a lot of the times they give it away for free right and then google play uh i guess oh right since we're not talking about android throughout the rest of the show as much i don't think um android has basically given uh the home territory or the real estate of most

mobile devices across the world to google for their add-on services so it's kind of um you could almost think about as a loss leader because they're able to sell so much beyond that um would you say that yeah yeah and i i will talk about that during that competitive advantages section a little bit but yes that is that is correct they give out a giveaway a lot of this for free but then they require the oems which are say samsung all the other providers that are not apple to use the google play store which is the equivalent for the app store for any iphone uh people that are listening to this episode and they also you know have to pre-download google Chrome, YouTube, all that good stuff. All right, Ryan, next question. Now that I think people have

understood the business is a tough one to get the hurdle away there. Who are Google's competitors and what advantages does Google have over them, at least in our opinion? And why has search retained about 85% to 90% market share globally? And why do we think that can continue? Yeah. I mean, just for starters, they compete with everyone in basically some capacity, But when it comes to search, there's a lot of people or a lot of takes out there that Google Search is going to die and that it's not going to be able to tout the same market share that it has today because of some format change or in some way they believe that Google Search is going to die. That's just not been the case, and we don't think it's going to be the case. So it's no secret that Google has pretty much a monopoly on the search market. Estimates have its PC market share at just over 80% and its mobile share at over 90%. Keep in mind, Google not only dominates mobile search through its own dominance in mobile with Android, but it actually pays to power Apple Safari searches as well. So it's getting – basically, it's taking share within that search also.

But there are still some other competitors. So Bing, which is owned by Microsoft, touts about 5.5% market share in terms of search. Yahoo, which is owned by, I think, Apollo Global, has about 3% market share. So they're still there. um yeah and if we look at uh i'm showing a sharing a screen here for any of the video ones microsoft won't talk about how the competition there is a little bit tougher where with bing they've gained market share a little bit on desktop but they are non-existent on mobile yeah exactly and then just to kind of like so i mentioned earlier that the page rank algorithm

them was an early differentiator for google's search results but that uh well microsoft they they're the tech to copy that yeah yeah that like that style of of ranking pages is certainly replicable but it begs the question why has google maintained its dominance for 20 plus years if it was copyable and so i found this quote from timo buss who's a portfolio manager at covesto Asset Management. He wrote this piece on Google. It was a really good piece. We'll link to it in our newsletter as well. He says, for ranking purposes, the company has stopped relying solely on backlinks. That's the sources part that I mentioned. Today, it takes over 200 different ranking factors into account, building on its almost 4 billion users. Search generates the

largest data set on global search and click behavior, which serves to continuously fine-tune the quality of its service this feedback loop is an important economic moat as competitors may copy google's ranking methods but hardly the aggregated usage data and you can really see yeah brett um okay i think you're going to go through something but before we get on to the next section i do have something to add on to that okay i the it's you see it not in like you know with a common search like auto insurance or something, like you'll get a lot of the same links across search engines,

but it's in sort of the marginal or the more complex searches where I recommend trying out the different search engines and you'll see the different quality of results and how Google's is still significantly better in certain searches. What were you going to say?

I was going to provide an example here. So I think, and again, And we'll talk about the AI chatbot tools that are kind of the newest threat that people think are going to upset Google. And I would listen or read the latest conference call because due to all the stuff in the news and the fact that the chat GPT-3 just got released, Alphabet did talk a ton about their AI tools and how they've invested in over the last decade. So they're talking about DeepMind and how that's helped powered search. They talked about a few different tools, I forget the name, that they've added into the back end of search to really help improve the results for the complex searches versus someone else. So for example, if you search something pretty complex, like how to fix this specific part on a Subaru Outback 2005, not only will they have links to articles, but they will link now to the exact moment in a YouTube video where that is

hit. So they'll put you at like one minute and 37 seconds. Okay. Click on this. Boom. It'll light it up. Or if you search for something that's more in the physical world, the Google maps will be embedded seamlessly as well.

So that's why both YouTube and maps connect together to make the search, the search product better. When you add on all these AI tools that according to the company are at an inflection point, separate themselves from someone like, well, especially Yahoo, but anyone that tries to, is seriously competing with them, like DuckDuckGo maybe, or someone who they just have no shot with that. Yeah, and the other with, in regards to the language learning models

like ChatGPT, this last conference call was really sort of oriented all around that, maybe even too much, I'd say, as a shareholder, but the It sounds like they're about to release their own open language learning model to the public. And so that'll probably come out, I am assuming, shortly after this episode airs. Recommend trying it out, maybe comparing the two tools because it'll be a testament to, I imagine, that advantage that we've talked about. If they're able to launch this that quickly after someone has basically primed to the market for them to enter it. I think it's a testament to that actual data advantage that they possess.

Another kind of example, I think, of highlighting this advantage is the Microsoft competition. So in 2015, Microsoft launched its own search browser called Microsoft Edge. This was intended to compete with Google Chrome. You think about it, Microsoft has the dominant operating system for PCs with Windows. And so it kind of makes logical sense for them to go after this. However, in 2020, Microsoft announced that it's pivoting Microsoft Edge from its own search framework to instead being built on Google Chrome's open source platform, Chromium. So they themselves basically said, hey, we're not going to be able to find the same level of searches. We're not going to be able to compete with Google. We're going to leverage Google and use them to power Microsoft Edge.

And there's some other reasons that you add Chromium or you power on top of Chromium as well. And then on top of it, Microsoft recent round of layoffs was apparently rumored, and this is more speculative on my side, But it's rumored to be focused around the edge division. My thought here is they see diminishing returns on investments into that because of Chrome's moat in the space. So they're trying to invest less in there. But that to me is just a prime example of how deeply embedded and how not only just their current advantage, but how that competitive advantage continues to grow the more data that's funneled through Chrome system. Yep. And I'm about to talk about this, how the entry point to the search engine is vital. And you can even see this. I'm sharing the screen right now, but I'll describe what it is. It's pretty easy.

if you look up, what do they call it? Microsoft Edge. So if you go load up Microsoft Edge at the bottom of your or on your Windows thing and you pop it up and you search in Microsoft Bing, Google Chrome, it'll pop up a promoted by Microsoft tab that says there's no need to download a new web browser. Microsoft recommends using Microsoft Edge for a fast, secure and modern web experience that can help save you time and money. So they're even trying to use their kind of monopoly as an operating system for anything outside of apple but chrome has been able to maintain that market share which i think is quite interesting yeah the only real risk uh or significant competition that i think of when it comes to search and you kind of raised

uh this idea before before we hit record is there's an increasing amount of search queries among young people that are just the searches are going straight to tiktok and instagram And they're not on search engines. Yeah. The competition isn't in search engines, it's kind of non-stuff that aren't search engines, but they're using it as it, right? I guess I don't have necessarily a response to that. My thought here is that if I'm thinking about this as the people that I know that tend to use TikTok and Instagram, very dominant among 10 to 20-year-olds. But I think as you enter the workforce, you have an increasing amount of search queries that are done on Google, as opposed to the kind of search queries that you have when you're 10 to 20 years old. So my thought would be those services like TikTok and Instagram aren't going to graduate with that cohort. Instead, they would probably, I mean, maybe at the margins it might, but still for certain searches, Google is the place to be. And it continues to kind of compound that advantage that they already have.

Yeah, I agree with that. And the only thing I would add on here is that YouTube most likely, well, I think will be an asset to compete with any of these ancillary products because YouTube is definitely taking market share from another alphabet business, Google Search, because it's grown so much over the years. And now you can search a lot of stuff on YouTube. People probably go there directly when they know they're looking up a video now instead of Google Search. And I think that can help them counter position themselves versus Instagram and TikTok. but it's still something we'll be watching closely. Go ahead, Ryan. It's worth mentioning that YouTube

is the second most prominent player in terms of search queries. So behind Google, the place where there are the most search queries is YouTube. So it is the second best platform or second largest in terms of market share. And maybe if Google seeds some share,

i think that's kind of youtube's for the taking yep and we're not going to talk too much about chat gpt here in the language learning models although we already hit it a little bit uh because it's kind of tbd or there's not really much we can add to the picture because it's so early in that process but we will be talking about apple in the next section which i guess i'll just talk i'll just say what you know if you want to ask me ryan yeah what so uh kind of a term that i think was coined by our friend yeah we stole it we stole it from someone yeah is it matt was the first one to mention that that i can think of i do not although we learned it from matt i do not think he was the first one to talk about that but yeah it's this concept of moat tests so you know people

say oh a company's got a moat uh it's it's hard to disrupt what they're doing a good way to kind of evaluate that is if it's been tested before so for google what do you think are some of the test that they've passed. Yeah. So this will be around why some of the things that they did to strengthen their business and why all the other things they acquired, all the other product they launched helped strengthen the Google search business today. And then I'll talk about maybe a little bit the upcoming risks. And we'll also hit that in a later part of the podcast. But as the largest single profit pool in business history so far, the Google search has seen numerous competitors over the past 25 years. I think a good rule of thumb that we have,

I'm sure other people have thought about it this way, but when you have a large business that has extremely high profit margins, as we looked, they've consistently had 25% to 30% profit margins while investing in all these moonshots. So the Google search business probably has, what would you guess, Ryan? 40% to 50% margins at a minimum. You're going to have competition. And when we look at it, sometimes your low margin can be the moat, someone like Costco, someone like Amazon e-commerce. But when you have high margins, you need to have a moat that is outside of the actual business you run. And Google's done that phenomenally. So they have few competitors today, right? Because when we looked at it, it's kind of

hard identifying the competitors when they have pretty much a monopoly. I guess you have Microsoft Bing as the only one who's deliberately trying to gain market share and therefore advertising revenue. And Bing, as I mentioned before, from that screenshot on desktop revenue has gone from about 5% market share to 10% in the last decade, which is something to watch. But if you look at historically, in the early 2000s, Google was mainly a desktop slash laptop business. There weren't smartphones, or if there were, they were not. We hadn't had the iPhone moment yet. It had major threats from browsers like Internet Explorer and incumbents like Yahoo, as it was not yet a platform business, but merely a great product that people... I mean,

it was the most popular website out there, but they had nothing else on top of it. And in order to fend off these incumbents and tighten its competitive advantage, it layered on new products for customers almost always for free. These include Google Chrome, which came out in 2008, Gmail, 2004, Google News, 2002, which I guess has since died, but was popular back in the day, Maps, 2005, and others. Yes, Google Search was itself a great product, as Ryan mentioned before, compared to the lackluster search engines of the 1990s. But by the 2000s, it was pretty easy to see how a larger technology company could copy them, and Microsoft did. These other products, I think especially Chrome and Maps,

enabled Google to pass a major moat test in the 2000s. Because once Chrome became the number one market share uh with what are those called browsers they that's how it's hard to describe but people know what i'm thinking here i think when you open your computer you open your phone and you go to search you go to your browser you're going to start you know you have the one you habitually use and then chrome as that market share they basically make google search the default search engine this is way easier than i'm explaining it but then on top of that they connect gmail they connect your google account they connect all this stuff it's your home make it it's your landing page it's your landing page and it's very very difficult to switch

and then there's no reason that you want to switch because the products are so good and free so how is somebody going to compete with that it's very very difficult now if we move to the early 2010s google needed to make sure it maintained its search dominance as the smartphone revolution took hold because once there's a platform change, you don't know, you got to kind of re... There's more competition that's coming down the line. There were threats that any of the platform owners like maybe Apple, Samsung, who else could launch their own browser or search engine, kicking Google to the curb as the default search engine for browsers on mobile. One mode test the company didn't really care about passing or feared

it wouldn't pass was with Apple. So where has it secured a license for Google search on all Apple products. Like Ryan mentioned, this license is now running at an estimated $20 billion a year. The exact numbers aren't known. So they decided not to go compete with them, but basically come and go in cahoots. And if you're an antitrust regulator, maybe ignore this part of the podcast because that is definitely... I mean, it's not anti-consumer, but it's definitely anti-competitive for those two companies because no one can really compete on search on Apple products. However, outside of Apple, Google made a masterstroke acquisition in acquiring Android. And did they get lucky because they acquired it before the smartphone revolution? Maybe.

But once the smartphone revolution took hold, they made some really strong moves and building into the second big player of the smartphone market, which actually has about 70% market share of all smartphones today, albeit with lower income households on average. But the smart things they did was they make it free most of the time for hardware providers to use it as their operating system. All they had to do in return was pre-install Google's core applications like Chrome, YouTube, Google Play, and Maps. And this enabled manufacturers to sell phones for cheap around the world, which is among other reasons why they have that 70% market share for smartphones today. And then to further increase its moat in mobile, the company has started to manufacture its own smartphones called the Google Pixel. although it only has a low single digit percentage of the market right now it is growing quickly and

on the last conference call they mentioned that they gained market share in every region around the world all right this is a long section but i'm going to keep going so google really passed its desktop and mobile moat test it also easily passed that voice technology moat test i guess from five or six years ago although that ended up being a lot more bark and no bite but if you remember people were saying that voice technology was the future um the apple license i think remains a weak link which were you know along with all the rest of investors we will be watching in the years to come i think what's interesting though is that if apple decides to build its own search engine and end its relationship with google apple alphabet excuse me will probably see

a bump in earnings in the short term but i think could start to lose significant market share over the long term if apple has its own search search engine on the safari browser for its devices however and here's the point that i think is interesting is because i was thinking about it um you know as someone in the united states that's under the age of 30 the the downsides of not having an iphone which i don't have one is pretty high for uh certain activities like courting other potential romantic mates if i wanted to switch to an iphone i think given all the holistic offerings gmail google drive um youtube whatever i'm missing some google maps i think i would still download google chrome what do you think ryan do you use safari

i know because it's the default or let's check right now i have a google folder on my uh on your on my iphone and i've got drive docs maps sheets google calendar google photos i don't have chrome uh so i use safari for search but but safari doesn't safari search if safari search started to suck like if they dropped the google license and i thought that it was like i was getting worse search results then i probably just download chrome here's what the thing though I like Chrome so much better. I do have an Apple product. And we're saying this personally, but I think the examples can go to everyone because everyone has these similar products. I have an iPad. And when I use Safari there, connecting to my Google account and all that

stuff is so much worse that I always go to Google Chrome now when I'm on my iPad, which I guess is not that often. So I think it's interesting, that counterposition. I don't know if it's a big risk but again apple could decide to end the relationship whatever they want and then right now uh they're facing that potential threat from microsoft being with um the chat gpt three stuff as microsoft has a really tight relationship with open ai who's kind of they're kind of combining forces to become a competitor with google we'll kind of see what happens there and then again we're you know we're watching the instagram tiktok threat to see if that ever it materializes but that's really it um ryan anything else to add there because i know it's a

lot of it's not a lot of numbers on that one it's more of okay think about their holistic offering and how it's tightened the noose around any sort of competition that could really step in yeah i'm yet to think of a moat test that they didn't pass what's something where they really lost well i mean they they're connected tv devices kind of suck but i'm about to talk to what i talk about why i think they're probably one of the best position within connected tv um yeah devices suck but that's not really much of a moat test yeah the voice technology i think remember when alexa was getting all that hype and amazon was marketing it like every day seemed like you'd see an advertisement for that about five six years ago they came up with google assistant it seems to

work fine but as we all know siri google assistant alexa don't really work that well there was a lot of hype there but it didn't really follow through i don't know i think the only mode test they didn't pass was the apple one because they passed it by paying them tens of over 10 billion dollars a year is it worth the price of the data that they ingest to improve their search results maybe maybe i think and i don't know i don't know if i leaned one way or the other i think it would be better for google to end the relationship just because of the antitrust stuff i also think it would be better for them to lower their fees on google play because it's as we looked earlier it's way less uh percentage of their overall profits than

apple's is so i think that would counter position themselves better with apple but But I don't think they're unhappy having this really tight relationship with the duopoly partner there in the space. All right, let's move on so we don't go too long here, although we want to be thorough on this episode. So we talked about search. We're going to kind of finish that section. And we think it's durable. We'll talk about this in the valuation, but fairly low growth. It's already so big, it can only grow so quickly.

But there are two segments within Google that we think have fantastic long-term growth prospects. let's explain each first ryan why don't you talk about youtube yeah everyone knows youtube it's the largest video sharing platform globally it's estimated to have roughly two and a half billion active users they don't i guess one thing that kind of pisses me off about google and a lot of people are probably in the same boat is they are very vague and they don't report a lot of the same KPIs, every conference call or anything like that. So you kind of have to read between the lines sometimes or base it off third-party estimates. Though in terms of usage, some estimates vary, but most sites assume that the average user on YouTube spends about a half an

hour to an hour on the platform every single day. And as I mentioned, even behind Google, YouTube has the second highest amount of search queries among all other platforms. If you just think about the core product or the core platform, it's really kind of a wonderful business and I'll talk about why in a second, but it allows for anyone that doesn't know the production side of things or how people upload, anybody can upload videos that they want. Once an account passes certain subscriber and hours watched thresholds, then they become eligible to monetize their content through YouTube ads. And so when you're running YouTube ads,

the creators collect 55% of every ad dollar, correct me if I'm wrong here, Brett, and YouTube captures the remaining 45%. It's got basically two wonderful characteristics that Brett and I specifically look for in investments, which is user-generated content. So the cost to produce content is basically free. And then wonderful network effects where the more people that are on the platform, the more content there is, the more reason to be on the platform, the more people that go to watch the content, the more incentive there is to produce more content. So it's really kind of those two wonderful characteristics. In terms of advertising, throughout for this whole year, YouTube reported about $29 billion in advertising revenue. However, YouTube has also

expanded the platform beyond advertising. So this first happened in 2014. The company first launched, it was called, I'm pretty sure it was called Music Key. It would eventually become YouTube Red. And then finally in 2018, they rebranded to YouTube Premium. But with YouTube Premium, users pay, at least in the US, and someone reminded me that it's probably lower in emerging markets, users pay $12 a month and they get unlimited ad-free videos. The videos are downloadable, so you can watch them later. You get a YouTube music subscription, which just for simplistic purposes, I think it's sort of like a Spotify competitor. And you can also listen to videos once you close your phone. So that's mostly for music most times,

but basically- Or a podcast. Podcast too. That's right. So if you have YouTube premium, feel free to, you don't have to watch, You can just listen to us with your phone closed. But last quarter, Sundar Pichai mentioned that they had surpassed 80 million subscribers to the service, although that does include trials. And there is emerging markets probably have a lower average revenue per user. But if you just do the rough math, let's say it was $10 a month in average revenue per user.

That's probably high. I'm sure that's high. 80 million subs, $10 a month, 12 months. you're probably looking at about $10 billion a year in revenue. That's actually up 60% from the spring. So this is growing really, really quickly. And another wonderful thing about this product that we've mentioned, or that Brett and I have talked about before is if you're a YouTube user and you're using it ad supported, so you're just getting advertisements, you've maybe noticed that you're getting a ridiculous amount of ad loads. It's like

almost unbearable maybe not ridiculous compared to like linear tv but i mean it's still beautiful you watch what an hour-long video you have like 60 seconds of ads that you can just click through absolutely not no way there's more ads than that there's way more ads than that in my experience and maybe it's maybe they monetize maybe they're just for maybe they're just friendly to me i don't know they just like me more right i think most people i've talked to are like you know it's kind of the general sentiment is like god they're just like loaded up on ads Part of the reason that they're able to do that, and this should be more proliferated here as YouTube Premium continues to grow, is when YouTube Premium grows and people opt to pay for no ads, you've got the same amount of advertisers wanting to advertise on a smaller user base. So potentially, you can increase the ad inventory or the ad load on that diminishing user base.

That's assuming that the overall users isn't outpacing that potentially. And so you can then just increase the ad load to further incentivize them to upgrade to premium more quickly. So it really is kind of that wonderful model. And then you potentially are able to raise CPMs on the advertiser side as well. Um, but beyond YouTube premium. And so I do think YouTube premium is a really good way, a really good lever to kind of grow the core YouTube product. Um, the other part I really like and thing I'm probably the most excited about when I look at this business is YouTube TV or basically their, their presence in streaming. So in 2017, YouTube launched their live TV streaming

platform um it costs 40 or 64 a month estimates have it at like 5 million subscribers once again they don't really report that but when you come when you look at the core youtube app on on connected tvs and youtube tv if you combine the two they have the number one they have the most usage of any um connected tv streaming service so second is netflix they are the largest yeah they're larger than netflix well at least in the u.s but i would guess they're i would guess they're larger internationally yeah i mean streaming connected streaming tv in general isn't as big abroad if i'm not mistaken yeah it's more um although it's getting there but yeah it's more mobile devices yeah yeah but i mean okay i'm a big believer in connected tv like the market as a

whole i think it's hard not to be if you look at it right now about 40 of all tv viewing in the United States is done through streaming or connected TV. Only about 10% or less of TV advertising is on streaming. So there's still a ton being spent on linear. More and more people are beginning to transition to streaming. We're starting to see a lot of the big rights holders. So the NFL, companies like that offer a lot of their games and content to streaming providers, even though there might be a smaller audience, they know which direction it's heading. Oh, and YouTube just signed that deal for NFL Sunday ticket, which should, it's a way to get the older audience, I think, connected to the YouTube CTV ecosystem and bring them in and say, okay, this can be your home screen. And then also, Ryan, you're about to add on this other thing that is going to help enhance that as well. Yeah. I mean, there's a whole bunch of stuff they're doing. So one of the things is primetime

channels. So here's a quote from, if you just look up primetime channels, it says, to combat the growing complication of subscribing to multiple streaming services to find the shows and movies you want to see, YouTube has devised a new feature called primetime channels. Primetime