Motley Fool Hidden Gems Investing - Google, DOJ, and Default Inertia

Episode Date: October 11, 2023

The DOJ’s anti-trust suit against Google is far from over, but details are emerging that show even the search giant knew the optics of their search default deal with Apple weren’t great.  (00:21) Tim Beyers and Dylan Lewis discuss: - How the DOJ is charging Google cemented itself as the search leader with exclusive deals with Apple. - Just how lucrative those deals were for Apple. - The similarities with this case and the government’s anti-trust case against Microsoft in the 1990s.  (14:46) Mary Long caught up with Motley Fool analyst Sanmeet Deo for a chat about airport security stock Clear and the race to the front of the line. Companies discussed: AAPL, GOOG, GOOGL, YOU Host: Dylan Lewis Guests: Tim Beyers, Mary Long, Sanmeet Deo Engineers: Dan Boyd  Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. P.S.A., if you're looking for something, you don't have to Google it. You can also use Bing, Yahoo, and DuckDuckGo. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst, Tim Byers. Tim, scale of zero to 10, what are we looking at in terms of caffeination right now? We're going to 11, Dylan. Let's not kid around. I'm about a half cup behind you, but I will get there, I promise. Today, we are looking at the DOJ's case against Alphabet's Google,

and one spot where AI may be affecting hiring. Let's start with the antitrust talk, Tim. So many of our antitrust conversations recently have been about potential deals and whether or not they will go through. In the case of the DOJ and Google, though, This is the government looking at past action by a company and saying it led to a monopoly or reinforced monopoly. Right. This is the deal between Google and Apple for over many years, in which Google became the default search engine across all sorts of Apple devices. But I think the one that's primarily at issue here is the iPhone, where if you were looking on the iPhone using Safari on the iPhone and searching on the iPhone,

your default search engine was Google. This has proven to be incredibly lucrative for Apple over time. Theoretically, incredibly lucrative for Google, but they're being very cagey about it, Dylan. I know we're going to get to it in a second, some of the things that current CEO Sundar Pichai said about this back in the day. He's being more cagey about it right now, but he wasn't so cagey in the past, which I think is very, very interesting. Before we get to those comments, let me just quickly frame up here to give folks a sense of how lucrative this could really be. Apple is a massive company today with about $119 billion in operating income. That's in fiscal 2022. Over the trailing 12 months, about $111 billion

in operating income. Reportedly, this deal is worth about $10 billion to Apple on an annual basis. What you're talking about is close to 10% of operating income for Apple from one deal that has a very long history, Dylan. This is significant. Yeah. And the arrangement for Apple would be incredibly high margin. What we're talking about here is essentially setting something as the default search engine and forgetting it and just leaving it there. There's been some talk about whether or not this is material to Apple. I think that perspective right there is pretty perfect, Tim. I think we can all agree that's material and something that is definitely benefiting the company

and both companies. You mentioned the Sundar Pichai comments earlier, back in 2007, when he was in charge of Google's Chrome browser, not the CEO of the company. He had written a letter to Larry Page and Sergey Brin saying, at one point, I don't think it's a good user experience, and I don't think the optics are great for us to be the only provider in the browser, even suggesting there should be other options as a dropdown. Those are coming up because he is now in charge and is having to answer for this arrangement that we have in place. Right. To put it in even more context around it, at that time, he said there should be, wait for it, Yahoo as an option. That is significant at the time, because Yahoo

who, we haven't thought about Yahoo as a legitimate search engine for decades, let alone years. So, yeah, this is very significant. And the fact that he brought this up at the time, I think, is very damaging to Google's case, because it makes it seem like what Google really paid for is not just space on the iPhone. It paid for exclusivity. Now, whether or not Google is willing to admit that it paid for exclusivity is an entirely different matter. And I'm not a lawyer, so I'm not going to make a legal judgment here.

But that sounds very suspicious. It sounds very damaging. And according to the report that we're seeing is that over time, as this deal was renegotiated, it was renegotiated to allow Apple to have other providers in different parts of the world. And to this day, Apple does have, if you use an Apple device in different parts of the world, your default search engine may not be Google, but in most of the world, it still is. And of course, there are ways that you can choose to have a different search engine on your iPhone.

But, I mean, Dylan, I'm a reasonably smart tech guy. I've never even tried to make a different default search engine on my iPhone. I am certain that it's possible. But I don't know how to do it. I know I'd have to go research it." I think that's part of the government's case. It's not instantly intuitive, which is what we want, right? Yeah, there is an inertia to things being defaults. The average person is not going to go out of their way to make those changes. When you solidify yourself there, you wind up in a spot where you are the 90% search

market share leader in the most valuable search market in the world. Google very smartly positioned themselves this way, but it seems like maybe they are finally having to pay for it. One of the things I see coming up with this case a lot, and I want to ask you about, Tim, is, there are a lot of comparisons to what is happening here and the government's antitrust case against Microsoft in the 1990s, with a very similar notion of pre-installed defaults gatekeeping what is and isn't there for consumers when they open a device. Do you feel like that's a fair comparison? I don't know that it's a fair comparison legally, but from the perspective of the narrative,

boy, the echoes here are just far too loud. Because at the time, for those who weren't there and didn't see this, the argument with Microsoft is that as part of their deals with different PC makers, they would ship, as part of your Windows license, you were shipping Internet Explorer as the default browser inside Windows. That really crowded out, which was the alternative at the time, which was Netscape Navigator. It really crushed Netscape's market share over time because it was very easy. Like you just pointed out, Dylan, if it's the default and it's easy to set up and it's right there for you and you don't have to go download it. Well, then that's largely what you're going to use. And part of the issue

at the time, which people may not remember, is Bill Gates wrote an internal memo that became public later about, and it was in some ways kind of a roadmap for Microsoft, and it was entirely about the internet and how important that Gates thought the internet would be to Microsoft. And of course, the Department of Justice absolutely used that as a sledgehammer against Microsoft at the time and said, this was intentional. This is what Microsoft wanted to do. They made it the default because they had to grab market share because they knew this was the most strategic market for them because the internet made the PC so relevant at the time, which is a legitimate argument. Now, again, let's separate the legality from the narrative, but I think that narrative was so strong, and it echoes so much with what Sundar Pichai was saying, saying like, look, this is

something we don't want to get caught in because we are essentially saying, if we're the default, we own this, and so we get all the advertising revenue, and we're going to pay Apple to play a little bit along with us here. It feels very familiar, Dylan, and that's not a good look at all. Interestingly enough, that decision, that antitrust movement against Microsoft, kind of opened the window for Google and for Chrome and for all of this other second wave innovation that we saw. Irony never disappoints, Dylan! Irony never disappoints! One of the things that's interesting about this is, we don't exactly know what

a remedy would look like if we wind up in a spot where the DOJ is successful here, there's discussion of, would there be a fine? Would there be proposed breakups for Google's search properties and its internet properties? Tim, what do you make of all of that as a risk to the business? Is it something you factor in at all, or you just say, this is the reality of owning shares of a business that is this big? I think it's part of the reality. I recognize this is something that could happen, and there are multiple scenarios here. I think the more likely, if history is the guide, the more likely outcome is a fine, maybe a very substantial fine. But let's remember that Google has a massive balance sheet. They have

a lot of cash. They generate a lot of cash. If it's a fine, they are going to be more than happy to pay it, and they can make this go away. If it is a breakup, and I think that's the unlikely scenario. But let's say it is. That is fine with me. I am an owner of Google shares. I will happily take the breakup. Give me my position in YouTube. Give me my position in Google Cloud. Give me my position in the Alphabet Core business and separate it all out. I will take that because I think that ultimately creates value for me as a shareholder. So I see that less as a risk, Dylan, as more as something that is a potential outcome, that I would be happy to see if that's the route the government goes down. I think it's more likely we'll see a fine. That's a short-term hit

that I think Alphabet could easily absorb. So, either way, I'm okay with this. But I do think there's a likelihood of consequences. I just don't know what the consequences would be. Gotcha. Over to our second tech story today. In a job market that is relatively strong, we are seeing some weakness in one zone, and that's IT. Tim, the unemployment rate for information technology jobs was higher than the overall jobless rate last month. The immediate take that I'm seeing online is, some AI automation may be impacting entry-level IT jobs. Does that hold water for you? Well, yes and no. Maybe no and yes. Maybe let's put those in order. The reason it's

a no is because I think we've all seen the number of layoffs in the IT sector, and it's been absolutely staggering. You can expect that a large number of those layoffs were more junior people. Although, I'm assuming, too, there are some other senior people in there. We have seen some startups with some founders that are closer to my age, and I'm in my 50s. That's actually a good cohort for venture capitalists to put some money behind, because you've got seasoned entrepreneurs who know how to do this. There's probably layoffs across the spectrum. There's that. But also, there is a lot of talk about AI as an automation mechanism. And I do expect there is automation happening. So, I think it's more like, Dylan, we've seen

a huge number of layoffs, and you have some IT firms that are unwilling, as business picks up, to hire back at the same pace, because they may be automating some of those jobs that previously were held by a person. So, for folks that aren't as dialed in on tech trends and the role that AI plays in businesses. What would AI automation replacing entry-level jobs look like at some of these places, Tim? Probably customer service jobs, maybe automated. Instead of a customer service agent who is sending out emails and responding to customer requests, that is probably something that's automated through maybe some bots. It could be having to route calls, maybe thinning

out your customer service department so that more of the requests are automated and handled via automation, and so you have a much smaller customer service department. I could easily see some elements of marketing and marketing automation handled by different types of AI workflows that are just doing things like maybe writing base copy, doing basic copy or updating website copy and things like that. Something that a marketing intern might do that now an AI might be doing. Really, it's not much of an AI. It's more like an algorithm, a machine learning system, that has a bunch of copy in it, and is doing automatically generated pages. It's not really doing anything intelligent, it's just automating things.

So, I do think there is a bit of an emphasis on automation, and we're categorizing that as AI. And you know what? There is something that's fair, but also unfair about that. But I do think automation is hitting a lot of these tech companies. So, where the jobs are in IT are probably a bit more senior, and the junior-level jobs are going to be a little bit tougher to get. So, that's a trend I expect to hold up for a little while. Well, Tim, no risk of us automating you away from being one of our Motley Fool Money guests. Oh, I hope not. I hope not.

Always love going to you for Tech Intelligence. Thanks so much for joining me today. Thanks, Dylan. Coming up, if you've been to an airport recently, you might know Clear. It's a company that lets travelers cut through the security line, but you might not know that it's a publicly traded company. Mary Long cut up with Motley Fool's senior analyst, Sam Mideo, for a chat about the business and the competitors in the race to the front of the line. You just found out that your sales team is at risk of missing quota. Don't panic.

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look like as an actual business model yeah so clear secure um tickered y-o-u their business model is basically simply we describe as an identity management platform. They use biometric technology to verify a person's identity by looking at faces, fingerprints, etc. It's not just an airport company, though a majority of the revenue still comes from there. But it's expanding to use cases such as stadium security, online identity verification by LinkedIn, financial security, like know-your-customer-type use cases, etc. Let's focus first on that airport security piece, because that's probably one that listeners are most familiar with. Clear Plus is the company's flagship offering. That grants

expedited entry to over 50 airports in the U.S. It comes out to about $189 a year. How many paying members does Clear actually have today? Clear has, as of the second quarter of 2023, over 6 million active Clear Plus members. Those are paying members. This is up from around $3.8 million as of the end of Q1 2021. Clare is a pretty sticky product with their net member retention above 90%. They have a key performance indicator that they use that they report. It's called the annual plus member usage. That's been steadily increasing over the past eight quarters. That kind of indicates how much utilization of their product, of their pass, is being utilized.

So, you know, the amount of verifications done over how many actual members there are. Interesting. Within the airport space and others, because you mentioned that Clear is kind of expanding into different sectors as well, are there any competitors that Clear is up against, or is this kind of the only game in town? So, one of the first competitors that you would think of when you think of Clear and the airport, if you've ever seen the airport, is TSA PreCheck. So, TSA PreCheck is solely focused on airport security and enrolling members through an online application and in-person appointments. And they rely on traditional documents like boarding passes, government IDs. It costs about

$85 for a five-year membership, offers no family plans or discounts. In contrast, Clear primarily serves airports, but has expanded to use cases, stadiums, other venues. They enroll members through in-person kiosks using biometric identification, fingerprints, eye scans. And they have an app, which you can also enroll on. It costs about $189 per year and offers family plans, free membership for kids under 18, and various discounts. So, a key differentiator for CLEAR versus TSA PreCheck is that it lets you skip lines at boarding gates and passport control desks in addition to the security checks. Now, an interesting thing is, in 2020, TSA actually awarded CLEAR what they call the TSA Biometric PreCheck Expansion Services and Vetting Program.

That's a mouthful. They have to have an acronym for that at some point, I guess. But as part of this program, CLEAR is going to leverage their network and resources to handle the TSA PreCheck subscription renewal processing and new enrollments for TSA PreCheck. So, while it seems like they would be competitors, they're actually more of complementary products. And in addition to this, Clear is going to be offering a bundled Clear Plus membership and TSA PreCheck subscription for new members. So, you can have both with a bundled offering that enhances your ability to get through lines and use their products.

So, TSA PreCheck, while you'd think right off the bat that that's a competitor, it's a little bit more of a complimentary service, especially with some of the partnerships and collaboration that they've been doing. There are some other smaller competitors like VeriFly and others that do some of this airport security type identification. But many of them don't have airport presence like Clear does. And that's been a huge staple of Clear's business, is having those kiosks, having that presence in the airport where passengers get an idea of what their business is all about,

what their offerings are all about. And they have ambassadors, which some people might get annoyed by because they try to sell them the pass at the airport. They do also help them with getting enrolled, using the service, what it could actually do for them. So you have someone to speak to at the airports to get a better understanding for that product. That's something that other competitors don't have. In terms of their biometric technology, some of the competition, I would say, is typically from big tech, Alphabet, Google, Apple, Microsoft, Meta. Some of those big tech companies, if they start offering more identity verification system software to help with that, that could be a competitor. Of course, having privacy and all that information with

big tech is probably going to be a concern for many people, given that they already have so much of our information. Do you want to really be giving them a lot more? So, that's kind of the competitive landscape that Clear is facing. When talking about the competitive landscape, you mentioned, I'll say, the threat of big tech and their handling of biometric data and how that could be a potential obstacle for Clear. But if we focus on Clear alone, what do they actually do with our data? Should we be wary of them? So, yeah. Look, you give them your driver's license, your passport, all this information that, wow, they have it all. But privacy is actually heavily embedded in the DNA of the company. They're committed to never selling

member data. They may use the data to improve their own marketing, but they're never going to sell your data to other outside parties. They've built a comprehensive information Security and Cybersecurity Program. Their platform is certified at the highest level of security by government regulators and is constantly being monitored and evaluated. And the Department of Homeland Security is certified, clears security program with a FISMA high rating, which is the highest designated designation according to the Federal Information Security Modernization Act. So, they do have some backing by government regulators, Department of Homeland Security, And they're under the microscope. If they're not careful, if they're not protecting that data,

those government organizations have much more inroads into really clamping down on them. Clear might be a bit of an older company than people might expect. And you've talked to me before about its founding story. How did Clear come to be? Yeah, it's an interesting story. It was founded in 2003, and it was originally named Verified identity pass. It was founded by Stephen Brill, who was a law writer and entrepreneur. It was kind of in response to the intensive security checks and long wait times after the 9-11 attacks. Probably thought, how can we improve this? By 2008, they had 250,000 paying customers. They're being used in 18 airports across the country. But then, due to unsuccessful negotiations

with their largest creditor, they had to file for bankruptcy and they ceased operations in 2009. In comes the two co-founders, now co-founders, Karen Seidman-Becker and Ken Kornick, came in, bought out the assets out of bankruptcy for $6 million, including hardware, access to the members, 250,000 members, the clear brand name, and licenses with the Department of Homeland Security and other organizations. Seidman-Becker and Kornick had come from the financial industry running hedge funds, and decided they wanted to buy this out of bankruptcy and run the company. Clear relaunched in 2010. It was a smart card company before launching pods and kiosks at airports, which many of you may have seen already. A partnership and investment by Delta

in 2016 helped accelerate their growth. Then they got $135 million in six investment rounds for various institutional investors. And United Airlines bought a stake in 2019. So, all that really started building their funding, building their platform. And it took almost seven years for them to reach one million members, but it's added each subsequent million in less than a year. So, it's been growing very fast. And so, ending in 2019, they had more than five million members. So, it's been around for a decent amount of time in a different entity, but it's really lately that it's definitely taken off. It's well-funded and has a strong balance sheet, which I like as well. The company went public in June 2021.

Since then, despite everything that we've talked about, the increasing enrollments, etc., the stock is down over 55%. It's now trading at about $17.50 a share. Again, that's in spite of increasing enrollments. The company's grown quarterly revenue since its public offering. And in its most recent earnings, which were the second quarter of 2023, it posted positive net income for the first time as a public company. So, if we could say all that, why has the stock slumped so much? Yeah. One of the things that intrigued me about this investment is that it's trading at almost like a 10% free cash flow yield, which is a 10 multiple on its free cash flow.

So, it's trading very reasonably, cheaply, actually. So, it's like, what's going on here? One, it's a very tightly held company. The co-founders own about 17% of the whole company themselves. And they have pretty much, I think it's 80% of the voting control of the company. And then the rest of the holders of the stock, there's some institutional shareholders in there, Bill Miller and some T. Rowe and some other institutional investors. So, the actual float that's out there is not as much as you might think. So, given that it's a very tightly held company, the stock's going to be very volatile. So, that definitely accounts for that. And it does have an 18% short interest in the company. So, that has probably been a result of some of

the declines in the stock. And as well, a couple other points. Since it's heavily into the aviation airport industry. As that industry news flow and things are discussed about that industry, the stock will trade on those data points. That causes some volatility in the stock. But I have no reason to believe that they can't continue to maintain the profitability, continue to grow memberships. While it could slow, they have stated the travel industry is still very strong. That's been confirmed by some other companies that are widely followed, like Booking and Airbnb and others, where the revenge travel, as they've called it, post-pandemic is still going. That could slow, for sure. I think another reason that the stock

may be trading down a little bit is because it does have a huge concentration in the aviation industry. All these use cases that I was discussing briefly before, they're working on, but there's no guarantee that that's going to be successful or even take off and that it will be a big platform that everyone's using and it's very ubiquitous. So there's probably a lot of skepticism around that. Yeah. Lots of potential, but for to expand into industries beyond aviation, but still early days for a lot of that, it seems. Sam Mead, thanks for clarifying clear for us. It's been great talking to you today. Yeah. Thank you, Mary. As always, people on the program may own stocks mentioned, and The Motley Fool

may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening! We'll be back tomorrow.