Alphabet Q4 15A – Apple of its eye.

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Great numbers, bad dependency on Apple.

• Alphabet reported very strong results as high end users shifting to the iPhone improved Google’s ability to monetise its services.
• Q4 15A revenues-ex TAC / EPS were $17.2bn / $7.06 compared to consensus at $16.9bn / $6.56 and RFM at $16.2bn / $8.42.
• Alphabet split out what it calls “Other Bets” which make up Fiber, Verily. Calico, Nest, autonomous vehicles and other long term investments.
• This piece generated $151m in revenues and $1.1bn in operating losses in Q4 15A with most of the revenues coming from Nest and Fiber.
• Stripping out the “Other Bets” shows just how well Google has been faring over the last 12 months.
• EBIT margins have risen to 37.9% in Q4 15A up from 35.0% in Q4 14A.
• While some of this benefit has come from increasing scale, I suspect that most of it is the direct and ironical result of Android losing market share at the high end.
• The greater usability of the iOS user experience when compared to that of Android means that an iOS device generates around double the traffic of an Android device at the same price point.
• Consequently, there is far more opportunity in iOS to target users with marketing resulting in meaningfully higher revenues.
• RFM estimates that Google’s revenue per user on iOS is more than double that on Android.
• Consequently, when the user shifts from Android to iOS, Google benefits in the short-term.
• The iPhone 6 product cycle has resulted in a meaningful share gain for iOS in the high end of developed markets and Google’s strong numbers since Q2 15A, are almost certainly a direct result of this trend.
• The problem with this is that Apple and Google are fierce competitors and Apple has been taking as many steps as it dares to remove Google from its ecosystem.
• This is a very delicate balancing act as the one thing that would make an iOS user consider switching to Android would be if Google services were no longer available.
• Apple Maps, ad-blockers and so on are all attempts to remove Google but so far none of them have really worked.
• For Google, this growing dependency is a major problem because if Apple ever gets into a position where it can safely boot Google from its ecosystem, it is very likely to do so.
• The effect on Google would be at least a $13bn hit to annual revenues and a collapse in its valuation.
• Furthermore, iOS is going to grow much more slowly now that the share shift is largely over, putting the emphasis back on Android as the engine of growth.
• Google appears to be unable to control the endemic software fragmentation that hampers the user experience which is why I think that it will end up taking complete control of the software.
• With the user experience under control, Google will be able to improve it to compete more closely with iOS as well as be able to distribute its software in a timely manner.
• However, this is going to take some time meaning that it remains heavily exposed to iOS in the short-term for which I think that 2016 will be a much slower year.
• With expectations for 2016E, now certain to move up, I am increasingly concerned that the shares have overshot fair value.
• I prefer Samsung, Microsoft, Facebook or even Apple to Alphabet.