Alphabet Inc (GOOG)

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Rearranging the Letters of Alphabet
By: Market Realist | December 31, 2019

The journey from Google (GOOG) (GOOGL) to Alphabet has seen ups and downs. Innovation needs time and patience, with no certainty of the future, which can make investors apprehensive. For Alphabet, its co-founders satisfied investors without compromising on their great tech dream. Let’s look at Alphabet’s story in detail.

The way of the co-founders

Since the very beginning, Google co-founders Larry Page and Sergey Brin were stubborn entrepreneurs with strong opinions. Earlier this month, The Verge described instances where the duo has made gutsy calls, from opposing search engine advertising and firing all Google project managers to Page’s acquisition of Android without informing then-CEO Eric Schmidt.

Throughout it all, they maintained their vision to develop technology that would change humankind. This aim was at the forefront when they developed Google’s search engine. The company’s Google X, Calico, and Verily Life Sciences platforms also share this aim.

Co-founders think ABC

Page’s and Brin’s first ten years at Google were exciting, bringing challenges, new products to develop, and strategies to execute. The co-founders’ much-awaited decade from 2000 to 2010 saw the commercialization of digital advertisements, major acquisitions, and the launch of Google’s web browser, Chrome. With the launch of Chrome, Google became an end-to-end provider of browsing services. Google also entered the smartphone segment with its operating system, Android One, and boosted its online ad business through YouTube.

Page and Brin played a major role in these developments, giving them a great sense of achievement. The business picked up the pace and generated massive revenue. By the end of the first decade of 2000, most of Google’s money-making segments had established momentum. Its revenue grew from $6 billion in 2005 to $29.3 billion in 2010. With few possibilities for innovation left in these segments, the co-founders were confined to supervisory roles.

Bored of being boxed up and filled with capital, the co-founders revived their exploring zest and launched Google X in 2010. In a 2015 investor letter, Page wrote, “Sergey and I are seriously in the business of starting new things. Alphabet will also include our X lab, which incubates new efforts like Wing, our drone delivery effort. We are also stoked about growing our investment arms, Ventures and Capital, as part of this new structure.”

Investors think XYZ

Google stock grew almost tenfold from $54 in 2004 to over $500 by the end of 2014, before the restructuring of Google. Investors seemed optimistic about Google as a search engine and advertising entity. They may have expected that any acquisitions made must support Google’s core business. Also, as many may have been hoping that the co-founders would stick to their original business, the reasoning for adding Google X to its portfolio may have been unclear to investors. Internet balloon and life science projects were certainly not expected from the browsing giant.

The Google X move may have made investors paranoid about investing in Google. In July 2016, Conor Dougherty of The New York Times wrote, “While investors still do not know X’s budget, they at least have a sense of the limits. In the first quarter, Alphabet lost about $800 million on what it called “other bets” — everything outside Google’s core search and advertising businesses.”

Investors’ reactions to Google Other Bets

Google’s core business made investors feel secure about their money. Chrome, Gmail, and Android had market demand and the scope to grow exponentially. However, Google X was so out of the box that it had no dependable working infrastructure. Anything created through Google X would require end-to-end development. Moreover, such moonshot projects couldn’t justify the consumer base. There was also no guarantee that the capital invested would churn out satisfactory returns. Some of Google’s projects selected for research were so unrealistic that they irritated investors.

In his 2016 article, Dougherty wrote, referring to Google X, “shareholders’ perceptions about the division were aptly summed up by a poster board in its Mountain View, Calif., offices. It had a picture of a burning $100 bill followed by, ‘Investors think we do this.’”

Stockholders’ biggest concern was the feasibility of such unrealistic projects and their ability to generate revenue. They feared that Google’s profit from search and advertisements would be used to compensate for losses by unruly subsidiaries. In Other Bets, Google lost more than $3.5 billion in 2015. Investors’ reluctance to accept Google’s moonshot segment strengthened calls to restructure Google. To learn more about some of the challenges facing Google, read A History of Google’s Visionary CEO Sundar Pichai.

The formation of Alphabet

In his 2015 investor letter, Page discussed the company’s many reasons for restructuring. Some key reasons included the following:

• Establishing efficient operations across the company.
• Allowing co-founders to explore and fund new avenues.
• Satisfying investors by providing a risk-averse business with assured revenue.

The co-founders arrived at a win-win strategy by adopting an umbrella business model, where a parent company would oversee subsidiaries and handle capital allocations. Alphabet became the parent company, and Google and subsidiaries fell under its umbrella. Subsidiaries were to operate independently and have their own CEOs, and Alphabet would support any subsidiary in distress or in need of capital...

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