February 5, 2014 – Google: King of the Kloud Krewe

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GOOG dominates the booming digital ad market – we expect Search, YouTube, local, AdSense, and other initiatives to keep the company in front, even with the shift to mobile, social and video, and in the face of able challenges from Facebook and Twitter. However, it is GOOG’s dominion over modern computer science that scaffolds this ad sales machine and that creates wholly new opportunities – in fields as diverse as robots, medical research, augmented reality, commercial hosting and the internet of things. The company has the world’s biggest, cheapest, and most powerful computing platform, and combining that extraordinary infrastructure with its world leading data management, algorithm development and deep learning software expertise puts it in prime position to attack the nearly limitless number of traditional businesses ripe for disruption from the cloud. In this context, GOOG’s seemingly out-of-focus moon-shot investments and acquisitions make perfect sense, even if they may be monetized by subscriptions, service charges, equipment sales, retail commissions, or transaction fees rather than ads. Ultimately, GOOG may be addressing a larger and more lucrative opportunity set than any other TMT player, with assets and skills that will make it difficult to beat as the cloud era plays out.

Advertising’s been very, very good to GOOG. After inventing a game-changing way to index and search a web-scale data base, then growing its search engine to dominance, GOOG began selling positions on its results pages as ads. Applying its ascendant computer science skills and massive data center infrastructure to the needs of advertisers has been an ideal monetization scheme for GOOG, which today commands more than 40% of the digital ad market. Along the way, the company took leadership in 3rd party ads, added YouTube’s top video ad platform, and pioneered the move to mobile. With digital still <25% of total US ad spending, and lower than that overseas, there is plenty of runway left, and it is little wonder that investors view it as an ad company at its core. 

GOOG is a big data company at its core. Advertising is product born of GOOG’s dominant data processing core. As we have written (Google: The Biggest Hammer in a World Full of Nails), the company invented most of the key technologies underpinning modern data center architecture and data base management, contributing its well worn ideas to the open source community as it moves relentlessly forward. It has the biggest, fastest, cheapest, and most flexible data center infrastructure on earth, running the most sophisticated analytic software ever written, overseen by the deepest and most decorated staff of computer scientists in the industry. This is a profound advantage in pursuit of opportunities that go FAR beyond search and advertising.

GOOG invests to address new markets. Understanding GOOG as a transcendent data processing company puts its acquisitions and R&D initiatives into focus. Many of these investments have been entrees to new businesses where the data center leadership can be leveraged. Examples include Google Glass (augmented reality, wearables), self-driving cars, Calico (health research focused on aging), and Nest (networked home automation). Acquisitions in pursuit of new markets can also strengthen important skill sets – e.g. Nest brings former Apple design guru Tony Fadell.

GOOG invests to add complimentary skills. The $400M acquisition of AI start-up DeepMind fits right in with GOOGs own research into deep learning, which has informed existing products like search, improved capabilities like voice recognition and translation, and enabled new services like Now. However, deep learning is also key to new areas, such as medical diagnostics and secure payments. It is also highly complementary to another recent GOOG obsession, robotics. Robots are a physical manifestation of computer intelligence, forced to cope with the ambiguity and variety of the real world, and have found their way into a long list of commercial and industrial applications. By making robots smarter, more sensitive, more autonomous and better able to adapt, GOOG will be able to address an almost limitless list of new applications for its computing capabilities.

GOOG invests to protect itself. Motorola was a defensive acquisition, bought for patents and to halt the legal/competitive threats that it was posing to the Android ecosystem. Android itself was a defensive product, launched to counter AAPL’s possible domination mobile and assure a wide audience for Google Apps. Google Fiber is defensive – a show of force to the cable MSOs and telcos that dominate broadband and dictate the speed with which users can access GOOGs services. So far, these investments have been effective, and investors can expect more of them

GOOG will employ broad monetization tools for future products. Because advertising has been so effective, many observers mistakenly downplay GOOGs ability to monetize using other tools. Already, the Compute Engine IaaS service and Google Docs are generating monthly payments from enterprise customers, Google Play is generating commissions, and devices, like Chromecast and the Nexus line, are generating sales revenue. Non-advertising revenue ex MOT doubled in 4Q13, and, while still very small relative to ads, stands to grow dramatically. Expect serious enterprise IT services (hosting and SaaS applications), new devices of all ilk (including an expansion of Nest’s home automation line and the pending commercial launch of Glass), broader e-commerce initiatives (including 3rd party delivery & logistics, and a more comprehensive payments solution), technology licensing agreements (automotive, med-tech, etc.) and media distribution (YouTube, Google Play, Android TV, etc.) to become increasingly important drivers of future sales.

A LOT of room to grow. The markets that GOOG can address are massive. Advertising and promotion is a $1T global market and less than 15% penetrated by digital. E-commerce addresses the multi-trillion dollar global retail business. Electronic devices, personal financial services, medical diagnostic tools, enterprise IT hosting and SaaS, – all of these are, potentially, trillion dollar global markets. Further in the future, GOOG’s investments in AI and robotics could yield new opportunities, limited now only by our imaginations. All of this is possible because of GOOG’s towering excellence in big data, deep learning and data center architecture.

For our full research notes, please visit our published research site.

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