Google’s Alphabet soup

The internet giant is splashing cash on opaque and strategically questionable ventures. For now it is getting the benefit of the doubt, says Alice Gråhns.

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Lavish spending is taking a bite out of margins

Internet giant Alphabet is splashing cash on opaque and strategically questionable ventures. For now it is getting the benefit of the doubt, says Alice Grhns.

"To skinflints, or even the mildly cost-conscious, there are aspects of Alphabet's spending that look quite high," says Lex in the Financial Times. Google's parent company has recently bought the Chelsea Market building in New York for $2.4bn. It is about to pay Google's CEO Sundar Pichai $380m. It has taken on another 11,000 staff in 12 months. And all this shopping is taking its toll on profitability. Alphabet's operating margin has slipped to its lowest level since Google floated in 2004.

The company spends billions on projects whose payoff "may never come or whose prospects are mostly opaque". For now, all we know about Waymo, the autonomous-car business, are the overall miles driven: five million so far. At Nest, the Wi-Fi cameras business bought for $3.2bn in 2014, "there was a one-off glimpse of its financial performance, and it was not pretty". In the last quarter of 2017 it appears to have generated an operating loss of $168m on $278m of revenues.

"Alphabet is starting to look like alphabet soup," says Robert Cyran on Breakingviews. And it's becoming more and more difficult to see what exactly is going on. Investors wanting concrete measurements "are getting squishy ones instead". Its $9.4bn of earnings in the first quarter, fuelled by a 26% year-on-year jump in revenues to $31.1bn, came with several changes in the way it presents results, and unfortunately none of them make gauging the group's performance any easier.

Alphabet has merged its Nest and Google hardware units. The former produces thermostats and the like; the latter speakers and other gadgets. This means "less duplication", but Nest has also been "lumped in the same reporting division" as Google's cloud and app store business. "There's no obvious reason why hardware, normally a low-margin affair, should be combined with high-growth web services." Google will also no longer break out clicks and how much it makes from them on advertisements placed on third-party websites. It's now talking about "impressions", or the number of times an advertisement is seen, because that is apparently what's providing growth. But impressions are harder to measure than clicks. Is it a coincidence that the sum it receives per click has fallen over the past three years?

Alphabet's comfortable profits cushion

Still, Alphabet's sales and "profit cushion" are growing rapidly so the group can afford to increase capital spending as much as oil giant Exxon in the past year, as Shira Ovide points out on Bloomberg Gadfly. The message is that "Alphabet is entering a period of serious investment, and investors should be happy about it".

It is copying Amazon by telling investors it is going to spend a lot and "demand that investors give it leeway to keep doing it". This is hardly a risk-free tactic given the history of "lavish spending without a solid payoff". But assuming Alphabet reveals more details about its business in the years ahead it would be interesting to know how much revenue YouTube produces, for instance the company has earned an "Amazon-like benefit of the doubt".

Britain's ten most-hated shares

CompanySectorShort interest on 24 Apr (%)Short interest on 27 Mar (%)
Melrose IndustriesIndustrials14.84115.339
Greencore GroupConvenience food15.0313.58
DebenhamsGeneral retailers14.6911.47
GVC HoldingsGaming operators14.4516.198
CarillionConstruction13.9914.8
Pets at HomePet retailers12.211.67
The Restaurant GroupRestaurants12.1111.61
Marks & SpencerGeneral retailers11.7611.24
J SainsburySupermarkets11.1610.88
AggrekoPower supplies10.38NEW ENTRY

These are the ten most unpopular firms in the UK, based on the percentage of stock being shorted (the "short interest"). Short-sellers aim to profit from falling prices, so it can be useful to see what they're betting against. The list can also highlight stocks that might bounce on unexpectedly good news when short-sellers are forced out of their positions (a "short squeeze"). Power-generation and testing group Aggreko is the new entry this month. A downturn in the oil and gas sector has undermined growth, with annual pre-tax profits falling 12% to £195m.

City talk

"Carillion will forever hold the title of the most self-deluded outsourcer," says Nils Pratley in The Guardian. But Capita, according to its new CEO, Jonathan Lewis, "deserves a place on the podium". Two years ago it raised the dividend by 9%; now it is issuing one billion new shares to stave off collapse. Why? Because Capita was a jumbled mess without a strategy. It is a result of 250 small acquisitions, and the operating businesses were never integrated into units. Lewis says everyone was accountable, so nobody was, thereby "in effect damning his predecessors".

"Who says it takes ages to turn around a supertanker?" asks Alistair Osborne in The Times. Not at ship-broker Clarkson. "One minute everything's going swimmingly." The next? "Glug, glug, glug." Six weeks ago, boss Andi Case said early indicators of recovery were "showing across our core markets". Now the shares have plunged 18% amid a profit warning. Case "has been hit by waves you'd have expected him to spot". Talk of a trade war and "jumpier" financial markets have dented demand.

Japan's Takeda has reached a preliminary agreement to buy Irish drugmaker Shire for £46bn, say James Fontanella-Khan, Kana Inagaki and Sarah Neville in the Financial Times. After rebuffing several proposals from Takeda, Shire's board "finally gave in" to its latest bid, a cash and shares offer that values the London-listed group at about £49 per share, £5 more than Takeda's first bid. This marks the largest foreign acquisition by a Japanese firm on record and "the culmination" of Takeda's attempts to go global and be able to compete with US rivals such as AbbVie.

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