Alphabet: Unveiling YouTube and Cloud Services
Alphabet Inc. ("Alphabet" or the "Company") holds the largest share in our portfolio, and we have covered it in our newsletter at various occasions. In this article, we will examine the opportunities in the Cloud and YouTube sectors and we will conclude with a revised valuation.
If you are interested in learning about Google's performance over its latest earnings (Q2'23), you can refer to the article Evolution AB, Novartis, Alphabet - Q2'23 Earnings review.
Report contents:
Introduction
YouTube
The Cloud
Valuation
Conclusion
1. Introduction
The stock: Alphabet’s market cap as of 10th of October stands at $1.75T with a 52-week low of $83.34 and a 52-week high of $141.2, whereas it currently trades at $138.1 with year to date returns of 56.5%. Analysts have a 12-month target price of $152.4 representing an upside of 10%.
Valuation: Alphabet trades at a TTM EV/EBITDA of 18.2x (5-Year average of 18.1x), a TTM Price / Earnings of 29.6x (5-Year average of 27.5x) and a FCF/EV yield of 4.3% (5-Year average of 3.8%).
Segments: Alphabet has 6 reporting business lines with the ‘Google search and other’, ‘YouTube Ads’ and ‘Google network Member’s’ representing the Google advertising business which accounts for 78% (or $226.2B) of its TTM revenues.
Source: Stratosphere.io (use coupon code STOCKOPINE for a 25% discount), StockOpine analysis
Google Other accounts for 10.8% or $31.2B and includes revenue from Google Play, Hardware (e.g. Pixel phones), and YouTube non-advertising, including YouTube Premium and YouTube TV subscriptions while Google Cloud which includes Google Cloud Platform and Google Workspace accounts for 10.2% or $29.7B.
What’s hot: Various news stories are circulating, including allegations from the Department of Justice that Google's search division maintained a monopoly by making annual payments of ‘$10 billion to secure its search engine as the default choice on mobile devices and web browsers’. Additionally, Amazon has made a significant investment of up to $4 billion in Anthropic, an AI company similar to OpenAI. Anthropic has chosen Amazon Web Services (AWS) as its primary cloud provider for mission-critical workloads’. This deal seems like a setback for Google Cloud, even though it appears to have been in the works before Anthropic encountered performance issues with Google Cloud. Alphabet's ownership of approximately 10% of Anthropic with around $300 million in funding makes this cloud deal quite perplexing, especially considering that gen AI is expected to be a major driver of the Cloud market.
Google Bard is Google's weapon in the AI arena, utilizing the Language Model for Dialogue Applications (LaMDA) for training while it also relies on the Pathways Language Model 2 (PaLM 2) to power advanced features such as coding and multimodal search. 'Gemini,' a new AI system, is a competitor to OpenAI's GPT-4.
Even though there are ongoing debates about which tool will ultimately prove to be superior, it's essential to recognize that AI is poised to become a key technology in our everyday lives. Its applications could be diverse, and there may be multiple winners in this space. Alphabet, certainly has the foundational strengths to excel, whether as a Cloud provider, an AI innovator, or both.
Without further ado, let’s jump into YouTube.
2. YouTube
In the modern digital landscape, YouTube has risen to become a household name, offering a mix of content that caters to audiences of all ages and interests. Founded in 2005, YouTube has come a long way from its beginnings as a platform for individuals to share their personal videos to an astonishing reach and impact that extends beyond entertainment such as education, music and business.
YouTube's long-term growth strategy has 4 pillars, which were shared by Phillip Schindler, Chief Business Officer at Alphabet.
“And to support this growth, we're focused on, number one, Shorts; number two, engagement on CTV; number three, investing in our subscription offerings; and number four, a longer-term effort to make YouTube more shoppable.”
User base
Understanding the YouTube phenomenon begins with an understanding of its user base. The platform's largest demographic consists of users aged between 25 and 34, however, no generational boundaries appear to exist. India with an estimated 574 million users stands out as the largest market for YouTube though it’s worth noting that most traffic comes from the US (~250 million users).
In total, YouTube has over 2.7 billion monthly users, ranking second only to Facebook (3.03 billion users). WhatsApp and Instagram of Meta secure spots 3 and 4 with 2 billion users each.
Source: Global Media Insights, Meta filings, backlinko for TikTok, StockOpine analysis
Other interesting YouTube statistics regarding its scale and network are the 51 million channels (a hub for content creators), the +2 million creators making money on YouTube (as of Q3’21) and the fact that it accounts for ~25% of global mobile traffic (more statistics can be found here).
Its creator-centric approach fosters a thriving ecosystem where content creators and viewers mutually benefit from each other's presence. As more creators join the platform, they attract diverse audiences, which, in turn, becomes increasingly appealing to advertisers. This virtuous cycle fuels YouTube's ongoing expansion, making it an ideal platform for advertisers.
Phillip Schindler, Chief Business Officer at Google, highlights the platform's effectiveness, stating, “Looking at YouTube holistically, according to our measurement partners, Nielsen, TransUnion and Ipsos MMA, YouTube delivers higher ROI than TV and other online video on average.”
In Q1’23 it was reported by Phillip Schindler that ROI was 40% higher than linear TV and 34% higher than all other online video.
YouTube Financials
Source: Company filings, StockOpine analysis
YouTube's advertising growth reached its peak during the COVID-19 pandemic, achieving $8.6 billion revenues in Q4 2021. A subsequent slowdown was observed, and the growth took a negative turn starting from Q3 2022. The decline in growth was largely affected by advertiser spend (finance, media verticals) and changing market dynamics.
It's worth noting that YouTube Premium subscriptions, that provide an ad-free experience, increased from 50 million subscribers in 2021 to 80 million in 2022. Meanwhile, YouTube Shorts, a feature similar to TikTok and Instagram/Facebook Reels, gained substantial popularity, growing its user base from 1.5 billion in Q3’22 to 2 billion by the end of 2022, with daily views skyrocketing to 50 billion from 30 billion just a quarter earlier. Beyond the expansion of Subscriptions, which offer an ad-free experience, the popularity of Shorts has had a negative impact on monetization and profitability for YouTube Ads.
YouTube is taking steps to enhance monetization, as highlighted by Phillip Schindler, who provided an example where,
“Laneige, Amorepacific's #1 premium skin care brand, was an early adopter [of Shorts Ads in awareness campaigns]. It leaned into video reach campaigns and new creative over a 10-day test to drive a 21% increase in unique users reached from Shorts and In-feed, all in a more efficient CPM."
It's important to note that Meta, one of YouTube's competitors, reported a substantial run rate of $10 billion for Reels in the latest quarter, up from $3 billion in Q3 2022. Yet, Reels monetization has not reached a revenue-neutral point for Meta. Meta's Reels across its Facebook and Instagram platforms are generating over 200 billion views per day, surpassing YouTube's daily views fourfold and demonstrating significant growth from 140 billion views in Q3 2022.
In our view, this underscores the significant potential for YouTube, particularly when we consider the rapid impact that monetization of the short-form video space can have on revenues. For instance, in the most recent quarter, Meta reported a 30% quarter-on-quarter growth in monetization for Instagram Reels and a 40% increase for Facebook Reels.