September 25, 2023

Examining Alphabet Through Our Four Foundational Investment Frameworks

In my estimation, Alphabet fits within all four of our foundational investment frameworks. I will explore this contention with you in the bullets below:

  • Vertically integrated product, capturing market share in stagnant mature industry: In some sense, Alphabet's three primary businesses fit within this framework. Google search has siphoned advertising dollars away from traditional, less AI-driven channels and into AI/ML-driven search. YouTube has siphoned advertising dollars away from traditional channels, such as linear TV advertising and radio, and into ads displayed on user-generated content. GCP has siphoned dollars away from traditional, on-prem data storage and compute. In each of these instances, Alphabet has also employed vertical integration to create a more compelling product relative to the incumbent solutions from which it has been siphoning said dollars.
  • Businesses that will execute a leveraged recapitalization in the coming years or are extremely disciplined with capital allocation via routine, robust share repurchase programs: As you know, this has been arguably my central bull thesis for the business, and it continues to be at the heart of my thesis for Alphabet. As of today, the business still has a rather de minimis debt burden, which gives it further latitude to aggressively repurchase shares, especially if its valuation remains depressed due to economic uncertainty and rising rates. In fact, for Alphabet, higher rates would actually be a net positive for shareholders, as higher rates would push down on the company's valuation further, thereby allowing it to repurchase more shares at even more attractive valuations, which would serve to accelerate the growth of fcf/share, as the denominator in fcf/share is reduced at a faster rate when a company can buy back shares at a lower valuation.
  • Quality cultures that breed innovation within the larger conglomerate: While this has been called into question for Alphabet, the recent success of GCP has demonstrated that the company remains capable of fielding new products successfully. I think, on some level, the reality is that new successful products are simply very rare. GCP's success has been extremely heartening and represents one of many attempts at fielding new products working out.
  • Growth through quality, moat-building acquisitions: Alphabet has also demonstrated an exceptional ability to make moat-building acquisitions, evidence for which can be seen in Alphabet's purchase and ownership of Android and YouTube. That said, I am doubtful we will see very meaningfully successful acquisition in the future; not due to lack of competence, but rather due to regulatory scrutiny. While unfortunate for shareholders, this should serve as impetus for the C-Suite and board to further push hard on share repurchases, whereby capital is gainfully employed on behalf of shareholders in a disciplined fashion.

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