Description

Preface:  This is not a 'deep dive' on Alphabet as this is one of the most covered companies and we are all familiar, but more of a brief tactical commentary on what appears to be a poor setup for the stock.  Goes with out saying, but given how widely owned it is, I welcome any and all feedback and hope the questions thread becomes interactive.

Google is one of the greatest businesses of all time.  It’s part of an oligopoly dominating the highly effective and lucrative digital advertising market through its unmatched search engine, digital properties, network of partners, and advertising tech stack.  But it was a huge beneficiary of the Covid pandemic, and it was a beneficiary of Apple’s iOS privacy changes, and these tailwinds are now being lapped at the same time that the overall economy and ad market are softening.  Moreover, the stock has been a relative ‘safe haven’ in an otherwise atrocious backdrop for technology stocks at large, and while it’s multiple is down relative to recent history, it still trades for ~11x EBITDA where it tended to hover pre-covid.  Taking a step back, advertising as a whole grew disproportionately over the last couple of years, way in excess of the typical ratio to GDP.  In 2019 (pre-Covid), the US advertising market was $230bn and is expected to be ~$320bn this year representing an astonishing ~40% increase over this short time frame.  The digital advertising market grew even more rapidly at an eye-popping ~78% cumulative rate over this same period from $135bn to $240bn expected for ’22.  These growth rates are well in excess of the cumulative ~12% nominal GDP SAAR grew over this time frame ($21.7 trillion to $24.3 trillion today).  Further, now that digital advertising represents ~75% of total advertising spend (of which 50% of digital is search), Google will be significantly more cyclically exposed than it has been in prior downturns (digital advertising was only ~15% of the market in ’08-’09).  The main issue for the stock is that estimates are way too high, with or without a recession (chart below).  Specifically, Google’s revenue had been growing ~$25bn annually pre-covid (TTM revenue Y/Y change in $), then this shot up during Covid to a peak of ~$75bn in early ‘4Q21, and while estimates are modeling a deceleration, they’re now extrapolating out at ~45bn+ each year.  There are a number of theories as to where all this new advertising money came from (additional trade spend from CPG companies, dollars that would otherwise have been spent on rent, etc), but the obvious culprit was businesses chasing the ludicrous amount of fiscal stimulus thrown at the consumer during the pandemic (these glory days are over). 

In summary, while Google is a great business with a good balance sheet, the risk reward on the stock going forward is not particularly compelling given: 1) advertising was pushed to unsustainable levels during the pandemic, 2) this stimulus is not recurring and the economy is slowing (and almost certainly going into a recession), 3) estimates reflect extrapolated high levels of growth off of this unsustainable base, and 4) the multiple is not yet at a level to reflect this.  Moreover, Google’s search business benefited from iOS’s privacy changes that allowed it to grab share from Facebook and this benefit is now being lapped (and Facebook has made progress on working through these issues).  Assuming digital advertising goes down ~10% in a mild recession, Google would likely do something like ~$85 of GAAP EPS and could conceivably trade toward $1700 at 20x earnings.  Yes, there are other assets that aren’t monetizing and there is cash on the balance sheet, but the market doesn’t typically give a lot of credit to those things when the core business is under pressure (look at META).  In the more immediate term, the data points to Google missing this upcoming quarter.  The street is at ~70.5bn of revenue for the quarter representing 14% growth, but this represents an implied acceleration on both a two and three-year stacked basis.  It’s also important to keep in mind that Google is going up against the hardest compare in Q2 as ad revenue grew an eye-popping 69% in Q2 of 2021.  This implied acceleration comes at the same time that SNAP has already pre-announced softness in May, major ad agencies (GroupM, MAGNA, Zenith) have recently started taking down ’22 global ad estimates, and individual checks have come back softer for both search and social (YouTube).  Revenue could easily come in with a ~$67bn handle (+HSD) or less for Q2 pointing to EPS of ~$23.50 (or less) vs street numbers at ~$26.50.  Rolling some of the weakness through could point to ~$105 (or less) of ’22 EPS and the stock could easily trade toward ~$2000 or ~19-20x a lowered ’22 EPS outlook.    

Catalyst

Analysts cutting estimates, Q2 earnings, advertising cuts into a recession