Friday, August 28, 2015

Google and Alphabet: What are the risks?

Should we have been shocked by the Google/Alphabet news?  Actually, I don't think so.  Let's step back for a moment and think about Google's collection of businesses.  The company is incredibly creative and innovative, but in the end, one major business generated most of the profits: search.   That business is certainly as mature as a steel company, but it's much further along in the life cycle than many of the new ventures that Google has launched (such as driver-less cars).   How do investors look at companies with a big business generating lots of cash, and a set of smaller more speculative ventures that are users of cash.  Well, they become skeptical of too much cross-subsidization, particularly if the synergies among the businesses are limited.  We have seen the pressure on Google in recent quarters, as investors demand returns from the high-profit search business.  They don't want to see too much of that cash diverted to unprofitable and speculative ventures.  On the other hand, we know that new ventures often struggle when embedded in larger organizations.   They need a certain level of autonomy to flourish.  Therefore, it makes sense to separate out the new ventures.  It gives them a better chance to grow with some independence, and it enables the main search business to focus on optimizing returns.  

Are there some risks though of this new structure?  A discussion on the Knowledge@Wharton site has highlighted some of those key risks very well.  Here's an excerpt:

According to Wharton emeritus management professor Lawrence Hrebiniak, “transparency … is good, [but] I don’t know if transparency translates into profits.” Trouble could follow if Google’s investments in projects like driverless cars and drones don’t make money, he adds. “The transparency could cause some investors to rethink whether they want to be invested in these other businesses and prefer to put their money in Google,” he says. “There might be some pressure, in time, to divest some of these bad businesses on the non-Google side.”

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