Alphabet inc - internet/advertising

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THIS REPORT WAS PREPARED EXCLUSIVELY FOR ACADEMIC PURPOSES BY GEORGIOS CHALKIDIS, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS.THE REPORT WAS SUPERVISED BY A NOVA SBE FACULTY MEMBER, ACTING IN

A MERE ACADEMIC CAPACITY, WHO REVIEWED THE VALUATION METHODOLOGY AND THE FINANCIAL MODEL.

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▪ We are bullish on Alphabet shares over the medium and long-term, given our target price of $1,289.8 per share, which translates into an upside potential of 25.2% in comparison to the current share price. However, the magnitude of the upside potential is highly dependent on the improvement of margins and the successful commercialization of Waymo.

▪ Alphabet’s revenue grew by 20% in 2016 and by 23% in 2017, and it is expected to grow by 19% in 2018, with the revenue mainly coming from Alphabet’s subsidiary Google and its ad business. It is expected that this will change in the near future with Alphabet relying more on its bets outside the ad market.

▪ YouTube & Waymo will be essential future growth drivers, as the Search & Display ad business matures. The online ad market will continue to be dominated by Google & Facebook. ▪ Valuation: We derive the target price using a DCF,

forecasting the revenue seperately for the company’s most important business units and using a WACC of 8.08% and a terminal growth rate of 2.75%. The detailed planning phase reaches until 2028.

▪ Key risks: 1) Low returns on ongoing investments 2)

Market sensitivity 3) Detoiriation in the ad market 4) New competitors 5) Regulatory environment 6) Brand image

Company description

Alphabet Inc. is an American multinational conglomerate headquartered in Mountain View, California. It was created in 2015 and functions as a holding company for Google and several former Google subsidiaries. Through its subsidiaries, Alphabet provides web-based search, advertisements, maps, software applications, mobile operating systems, enterprise solutions, commerce, and hardware products.

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HALKIDIS

[email protected]

Alphabet delivers alpha

Strong growth & dominating market position

Recommendation: BUY

Price Target FY18: 1,289.8 $

Price (as of 5-Jan-19) 1,030.1 $

Reuters: GOOG.OQ Bloomberg: GOOGL:US

52-week range (€) 926.18-1252.89 Market Cap (€m) $893,708.6 Outstanding Shares (m) 692.9 Expected Shareholder Return 25.2% Source: Company Data, Bloobmerg

Source: Bloomberg

(Values in € millions) 2017 2018E 2019F Revenues 110,855 133,877 154,738 EBITDA 33,061 35,628 47,646 Net Profit 14,072 22,717 29,962 Operating margin % 23.6 19.7 22.2 EBITDA margin % 29.8 25.5 28 Profit margin % 12.7 17.2 19.4 EPS in $ 20.3 32.79 43.24 Ad/Other revenue: Ad Revenue 95,375 111,666 129,088 Other Revenue 1,203 1,203 2,244 Source: Company Data

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ALPHABET INC COMPANY REPORT

THIS REPORT WAS PREPARED EXCLUSIVELY FOR ACADEMIC PURPOSES BY GEORGIOS CHALKIDIS, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS.THE REPORT WAS SUPERVISED BY A NOVA SBE FACULTY MEMBER, ACTING IN A MERE ACADEMIC CAPACITY, WHO REVIEWED THE VALUATION METHODOLOGY AND THE FINANCIAL MODEL.

M

ASTERS IN

F

INANCE

Alphabet Inc - Valuation Summary

In order to value Alphabet we used the primarly the Discounted Cash Flow method. We came to the conclusion that only the DCF is able to capture the various growth drivers of Alphabet in appropriate way. More detailed remarks can be found in the

corresponding Excel Workbook. In the following a summary of our forecast and valuation results. We used a WACC of 8.08% and terminal value growth rate of 0.275 for our valution. Alphabet operates with a debt-to-enterprise value of below 1% .

We calculated a target share price per share of $1,289.81, which corresponds to an upside potential of 25.2%. Our result was tested on robustness with the help of a Sensitivity Analysis, a Scenario Analysis and a relative valuation based on trading multiples

Share Price Probability Base Case $ 1,289.81 60% Worst Case $ 1,040.54 25% Best Case $ 1,463.39 15% Average Share price $ 1,253.53 100%

Scenario Analysis

Enterprise Value Core Business $ 787,993.62 Value Non-Core $ 98,969.00 Net Debt $ 6,746.00 Market Capitalization $ 893,708.62 # of shares outstanding 692.901 PPS as of 25.11.2018 $ 1,030.10 Calculated PPS $ 1,289.81 Upside Potential 25.2%

Valuation Base Case

Alphabet DCF Valuation FCF Calculation

in Mio USD 2016 2017 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E

Revenue $ 90,272.00 $ 110,855.00 $ 131,877.05 $ 154,738.44 $ 176,226.01 $ 198,408.98 $ 217,410.82 $ 237,209.75 $ 256,855.18 $ 276,345.18 $ 295,923.11 $ 316,258.88 $ 336,694.70 Revenue Growth 23% 19% 17% 14% 13% 10% 9% 8% 8% 7% 7% 6% EBIT $ 23,716.00 $ 26,146.00 $ 25,930.96 $ 34,307.13 $ 39,396.93 $ 46,753.86 $ 52,717.55 $ 54,231.84 $ 59,155.94 $ 64,319.12 $ 69,910.89 $ 76,290.68 $ 80,815.00 EBIT margin 26% 24% 20% 22% 22% 24% 24% 23% 23% 23% 24% 24% 24% Net Taxes $ -4,257.60 $ -14,054.30 $ -4,426.26 $ -5,856.02 $ -6,724.82 $ -7,980.60 $ -8,998.57 $ -9,257.05 $ -10,097.56 $ -10,978.88 $ -11,933.36 $ -13,022.36 $ -13,794.63 NOPLAT $ 19,458.40 $ 12,091.70 $ 21,504.70 $ 28,451.11 $ 32,672.11 $ 38,773.26 $ 43,718.98 $ 44,974.79 $ 49,058.38 $ 53,340.24 $ 57,977.52 $ 63,268.32 $ 67,020.37

Deprecation & Amortization $ 6,144.00 $ 6,915.00 $ 7,735.03 $ 9,075.93 $ 10,336.25 $ 11,852.78 $ 13,670.62 $ 14,915.56 $ 16,150.85 $ 17,376.36 $ 18,607.41 $ 19,886.11 $ 21,171.09 Net Capital Expenditures $ -10,822.00 $ -14,449.00 $ -15,330.93 $ -17,447.44 $ -18,243.02 $ -21,480.27 $ -21,070.05 $ -22,625.38 $ -23,800.90 $ -24,965.88 $ -26,231.17 $ -27,804.97 $ -29,128.92 Change in Goodwill $ -599.00 $ -279.00 $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -Change in Net Working Capital$ 2,942.00 $ 4,458.00 $ 2,105.49 $ -2,440.03 $ -3,977.97 $ -5,316.71 $ -6,630.55 $ -2,735.87 $ -2,661.66 $ -2,561.23 $ -2,457.09 $ -2,389.04 $ -2,242.54 Change in Other Assets $ 2,508.00 $ 9,531.00 $ 9,761.70 $ 10,346.14 $ 8,826.87 $ 7,657.76 $ 5,559.94 $ 5,564.77 $ 5,521.63 $ 5,477.94 $ 5,502.66 $ 5,715.66 $ 5,743.78 Unlevered FCF Core Business $ 19,631.40 $ 18,267.70 $ 25,775.99 $ 27,985.71 $ 29,614.24 $ 31,486.82 $ 35,248.94 $ 40,093.88 $ 44,268.31 $ 48,667.44 $ 53,399.33 $ 58,676.07 $ 62,563.79

Historical Analysis Forecasted Financials

Beta 1.35

Risk Free Rate 3.21% Market Return 6.85% Cost of Equity 8.1%

Cost of Debt 3.4%

Tax Rate 35%

Debt / (Debt + Equity) 1% Equity / (Debt + Equity) 99%

WACC 8.08% Discount Factor FCF 2029 $ 1,205,483.39 Present Value TV $ 512,678.50 TV growth rate (g) 2.75% WACC - g 5.33% % Total EV 58% Terminal Value

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THIS REPORT WAS PREPARED EXCLUSIVELY FOR ACADEMIC PURPOSES BY GEORGIOS CHALKIDIS, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS.THE REPORT WAS SUPERVISED BY A NOVA SBE FACULTY MEMBER, ACTING IN

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Company Overview

Alphabet Inc. is a holding company incorporated on 23 July 2015. The company's business portfolio includes Google and other companies like Calico, Nest, Waymo, CapitalG, Deepmind and Verily. Alphabet segregates its business into two segments called Google and Other Bets. The Google segment is mainly active in the advertising industry. It also engages in sales of digital content, offerings of apps and internet cloud services, and to a lower extent the sales of mobile phones and other hardware. The ‘Other Bets’ segment includes all different types of companies which again are engaged in a broad variety of industries. Some of them offer various types of internet and television services, other again sell smart home appliances (e.g. Nest), and other again strictly focus on research and development (R&D) services.

The company mainly generates revenue by providing advertisers with powerful tools and services that allow them to run advertising campaigns and also measure their effectiveness. Alphabet’s advertising solutions help companies to reach new potential customers and to create new opportunities. The ad products are mainly sold over an auction-based advertising program. The offered tools also help to create text-based advertisements which then are supposed to appear on Google properties like their search engine or on properties of Google Network Members.

Exhibit 2: Company Overview Alphabet. More detailed overview in the Appendix. (Source: Own creation)

Shareholder structure

As of October 2018, Alphabet maintained a triple-class share system, with Class A and C representing the floating shares. The Class C shares do not grant the hol ders voting rights. Share Class A holders are entitled to one voting right per share. The shares of Class B are a special type of shares which grant the holders 10 voting rights per share. Furthermore, Class B shares are not publicly traded or 7.2% 6.2% 5.2% 82.2 % Vanguard BlackRock FMR Others

Exhibit 1: Shareholder Structure of Alphabet Class A shares – as of Oct. 2018 (Source: Company Data)

42.5% 41.1 % 9.1% 7.3% Page Larry Brin Sergey Schmidt Eric

Others (Google Insider) Exhibit 3: Shareholder Structure of Alphabet Class B shares - as of Oct 2018 (Source: Company Data)

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listed and are held exclusively by Alphabet employees. Class C shares represent slightly more than 50% of the total share amount. This structure allows that the two founders of Alphabet Sergey Brin and Larry Page to keep together a voting power of 51.1% despite owning no Class A shares. Thanks to their ownership of a significant amount of Class B shares the two can control the company’s decision. The Class C shares were created back in March 2014 as part of a stock split. Due to the introduction of the third category of common stock, all Alphabet shareholders received two Class C shares for each Class A share they held. The introduction of the share class system, back then a rather uncommon practice, allowed the management to retain voting control while divesting the majority of the economic interest in their company. Most Alphabet shareholders are comfortable with the idea of having practically no control over the company, given the long-term returns the stock is providing. First and foremost, Brin and Page have proven that they can maintain the company’s success. Over the years Alphabet successfully dominates the ads market and keeps up at the same time with the swiftly shifting trends of the markets. Alphabet’s management elegantly managed the shift to web-enabled mobile devices and continuously delivered remarkable growth and a sustainable positioning of Alphabet. Therefore, our view is that the founders’ power over Alphabet is to be considered beneficial.

Core Strategy

Alphabet’s current strategic mix is still heavily shaped by its main subsidiary and predecessor Google. Even after the reorganization, Google's advertising business was the main revenue driver as in 2017 it still accounted for 86% of Alphabet’s total revenue. However, the company is in a phase of upheaval, as Alphabet tries to diversify its sources of revenue significantly in order to rely less on the ad selling business. Alphabet combines organic and inorganic growth strategies. Ever since Alphabet pursues an extensive M&A program to extend and complete their product portfolio. The main strategy of Alphabet and especially of its subsidiary Google is to get the user to use and engage with their products and to monetize their engagement without compromising the user experience. Alphabet’s most promising initiative outside of the Google ecosystem is the self-driving technology development company Waymo. To guarantee to stay ahead of the competition, Alphabet shows a high degree of innovation. They never cease extending and improving the functionality of their products. This is facilitated by the vast profitability of its core business units (Search & Display) which set free cash amounts that can be funneled into new projects, ideas and the hiring of strong talents. Its investment companies (CapitalG, GV, etc.) and incubators (e.g. Jigsaw) make it easy for Alphabet to effectively channel its money into interesting investment opportunities in their early growth stages. Exhibit 5: Alphabet’s Ad Revenue

(millions of $ and % of total revenue) (Source: Company Data)

95,4 111,7 129,1 145,7 161,2 86% 85% 83% 83% 81%

2017A2018A 2019E 2020E 2021E 25.9%

25.2% 5.6%

2.8% 40.5%

Page Larry Brin Sergey Schmidt Eric Vanguard Others

Exhibit 4: Voting Power of Alphabet Shareholder - as of 03.10.2018 (Source: Company Data)

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Alphabet also invests heavily in R&D. The two best-known R&D subsidiaries are Verily and ‘X’. Verily specializes in R&D in life science. ‘X’ describes itself as a company that takes moon shots. In other words, ‘X’ is a company that undertakes highly experimental projects. They do not focus on any specific area. The most famous success of ‘X’ is the subsidiary Waymo.

▪ Google LLC

Google LLC is the central pillar of Alphabet’s business. Google is specialized in internet-related services and products. Google’s revenue is almost exclusively generated through their online advertising business. The subsidiary’s most important products are Search, Ads, Maps, YouTube, Google Cloud, Android, Chrome and Google Play. Google LLC also offers hardware with Google Home and the Pixel being the most important. Two components determine its core strategy: 1) Maximize the size of the user base and their engagement: Continually extend its user base worldwide; Development and creation of new products in order to offer a more comprehensive user experience; Bound the user as strong as possible to its ecosystem; Undertake supplementary efforts and initiative in order to maximize and improve the product’s reach and its availability (e.g. Android, Google Hardware); Proactively add new features to its products to improve the user experience; In this first step, the primary goal is to create a solid user base, which then can be targetted by advertisers. 2) Enable

businesses to reach potential customers using Google’s paid tools:

Facilitate interactions between businesses and potential customers; Nurture the creation of new commercial opportunities; In this second step, Alphabet monetizes its platforms mainly by displaying several types of ads which are sponsored by businesses. This strategy is universally applied to many of Google’s products (e.g. Google Search, Google Mail, YouTube, and Android). In particular, Google uses its ad selling platform Google Ads (former name: AdWords) to monetize its products. Revenue is mainly generated whenever an advertiser gets a click on his ad. The exact amount the advertiser has to pay to Alphabet is given in the size Cost-per-Click (CPC). The CPC is set for each advertiser individually through bidding auctions, and its height essentially depends on the advertisiers preferences regarding keywords, geographic range and campaign length. Google Ads also offers more exotic payment methods e.g. Cost-per-Impression where for example the advertiser pays every 1,000 times his ad appears and is viewable. However, for our valuation, we focused on the CPC metric as this is the main billing method advertiser choose and also the one which Alphabet displays as a key performance indicator in its annual reports.

60% 27% 17% 7% De skt o p S e arch M o b ile S e ar ch G o o gl e Di sp la y Yo u Tu b e 47.3% 32.5% 14.6% 5.5% United States EMEA APAC Other Americas Exhibit 6: Estimated EBITDA margins in 2017 (Source: Morgan Stanley)

Exhibit 7: Alphabet's revenue distribution by geography in 2017 (Source: Company Data)

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Alphabet’s major profit drivers

Not only Alphabet has a broad and complex network of subsidiaries and products, but also Google itself owns and offers a broad range of products. For our valuation, we decided that the most relevant products are Google Search

Desktop and Mobile, Google Display and YouTube. Those four segments

alone accounted for 86% of Alphabet’s total revenue

in

2017. As Alphabet does not disclose detailed revenue splits we had to estimate a revenue split based on Analyst consensus. We used the revenue splits suggested by the Analyst teams of Morgan Stanley, Evercore and UBS and calculated the average based on their estimates.

▪ Google Search Desktop & Mobile

The search engine was Google’s very first product. Today it is still by far Alphabet’s most renowned product. The primary purpose of Google Search is to search the internet for text that matches the user's input. After the user types in his request and executes his search, the result page pops up and shows him a list of matches. The order of the results appearing is determined by a network of algorithms with the patented priority rank system "PageRank" being the most important one. The algorithm network evaluates the websites using over 250 indicators. New features and adaptions to the ever-changing user demands are implemented on a continuous basis. Google was able to build a machine nimble enough so that it can absorb new ideas brought up by its competitors. In the industry, it is an acknowledged fact that Google’s search algorithm delivers the best search results for their users.

Google Search generates revenue for Alphabet through selling ads space on their results page to advertisers over their ad selling platform Google Ads. The positioning of the ads is continuously optimized. Currently, Google lets ads on their result pages mimic organic/real results with only a small, green “ads”-symbol revealing them as a paid advertisement. We estimate a 60% EBITDA margin for the Search segment. The estimate is in line with analyst consensus (e.g. Morgan Stanley). Currently, ads on desktop PC’s tend to be more expensive than on mobile devices with the average CPC on Search Desktop being around $0.7 in 2017 and on Search Mobile around $0.47. However, we expect this to change in the next few years as our analysis of the internet ad market suggests that desktop search ad spending is decreasing and mobile search ad spending increasing. Consequently, we expect mobile search ads to reach a higher CPC than desktop search ads in the foreseeable future.

93%

Google bing Yahoo! Baidu Other

Exhibit 9: Distribution of the Search Engine Market in October 2018 (Source: gstatcounter.com)

Exhibit 8: Estimated revenue split for Google in 2017 (Source: Morgan Stanley, Evercore, UBS)

31% 27% 16% 13% 13% Search Desktop Search Mobile Display YouTube Other

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Desktop: In November 2018 Google had a market share of 91.46% on the

Desktop Search engine market. The two closest competitors (Bing & Yahoo!) had a cumulative market share of only 5.73%. According to our analysis, the average Cost-per-Click fell by 3.9%, namely, from $0.73 in 2016 to $0.7 in 2017. We see the main reason for the decrease in Desktop users generating less and less traffic. The trend that more and more searches are carried out on mobile devices continued in 2017. According to the website SimilarWeb, 57% of all visits were carried out on mobile devices in 2016 and up to 63% in 2017. In our opinion, mobile devices will continue to gain more traffic and will remain more interesting for advertisers in the coming years as it also generates more clicks per internet user on average. This will be reflected in the willingness to pay of advertisers. Estimates from eMarketer also support our prediction. eMarketer predicts that advertising spending on Desktop Search will continuously decrease in the coming years. They expect negative growth rates ranging from -10.2% to -12.7% for the period 2018-2022.

Mobile: On mobile devices, the market share amounted to 93.59% in November

2018 with the two closest competitors (Yahoo & Baidu) having a cumulative share of only 3.4%. The average CPC is steadily increasing and doubled over the last 3 years from $0.23 in 2015 to $0.47 in 2017, according to our calculations. We expect the Cost-per-Click to continue to increase in the foreseeable future. We see this as a reasonable prediction as mobile search ad spending by advertisers is expected to continue to increase in the next years. However, we expect that the growth rates will only slowly start to decrease. As already mentioned the Cost-per-Click currently on Mobile Search is lower than on Desktop Search. We predict that this will change over the next two years and eventually in 2019 CPC on Mobile Search will surpass the CPC on Desktop Search. We consider the Mobile Search unit as one of the essential growth drivers in the next few years. Smartphone user penetration is expected to increase from 30% in 2017 to over 40% in 2021. This will naturally lead to additional users of Google Search on mobile phones. Especially, countries with comparably low smartphone user penetration rate today and high total population numbers (e.g. India or Indonesia) offer optimal future growth opportunities. Regarding search traffic, our calculations showed that in 2018 Google Search will carry out circa 2.2tn searches. This is a growth of over 83% since 2012 when Alphabet was still officially publishing the number of searches per year (see Exhibit 10). More searches per year translate into more time spent on Google Search giving ads on Alphabet longer air times and generating more clicks and, thus, more revenue for Alphabet.

Exhibit 11: Revenue Model for Google Search & Display

998 1.109 1.216

2.227

2010A 2011A 2012A 2018E Exhibit 10: Google Search queries per year in bn (Source: Company data, internetlivestats.com)

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One can see that Alphabet is strictly dominating the whole online search market in every segment. In our opinion, Google Search owns a monopoly on the online search market. However, Google did not gain its market power through anti-competitive measures or coercion but by merely offering the most advanced solution on the search engine market. Naturally, on the internet the market entry barriers and switching costs are low. Moreover, over the years many well-capitalized companies have attempted to win market share over. The most aggressive and recent competitor was Microsoft's Bing. However, none of these competitors were able to offer better search results and functionality. One also has to keep in mind that Google was not the first existing search engine. Back in the nineties, Google was just a small start-up that beat out billion dollar companies such as Microsoft, Yahoo, and AOL, which were dominant in internet searches at that time, by merely offering a superior product which was delivering better results. The technological superiority of Google’s search engine constitutes a unique competitive advantage over its competitors on the search engine market. How this market power at the search engine market influences the internet ad market will be discussed in our sector analysis, where we will also take into account the interdependencies with the second internet ad market giant Facebook.

▪ Google Display

The idea of Google Display started back in 2003. With its Google Display business segment, Google makes revenue by serving ads, not on its own properties, but on properties of businesses who allow Google to display its ads. In exchange for offering Google ad space on their properties the so-called Google Network members get a share of the ad revenue generated on their property. This share which Google is paying to the Network members is a significant cost position and is listed as Traffic Acquisition Costs in Alphabet’s annual report. In order to become a Google Network member who can offer its ad

Exhibit 13: Ad Spending - Search Desktop & Mobile (in m $) (Source: Magna Global) Exhibit 12: Mobile app

monetization platform shares of apps installed in % in Dec 2018 (Source: Appbrain.com) 59.59 28.63 20.96 13.57 13.42 A d Mo b Fac eb o o k A d s Un ity A d s A p p Lo vin Mo P u b

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space to Google one has to use the program AdMob, if they plan to implement ads on a mobile application or AdSense for any other property as traditional websites. In 2018 the Google Network consisted of over 2,000,000 million websites and over 650,000 apps.

The idea to “rent” ad space on other businesses’ websites came up in early 2003. After acquiring the company Applied Semantics a few months later for $102m, Google formed the platform AdSense. If a website owner decides to monetize his website with Google AdSense, he has to enroll through the website and, eventually, implement a Javascript code on his website’s page. AdSense then analyzes the traffic and the content of the website and displays ads relevant to the content of the website. Dependent on the type of ad space rented Google pays a share between 51% and 68% of the ad revenue to the website owner. According to statista.com Google Display could claim a market share of 13.8% in 2016 and of 12.5% in 2017 on the internet display market. The decrease is mainly caused by increasing competition in this particular ad market segment (e.g. Facebook, Snap and Amazon).

AdMob was founded in 2006 and became a part of Google in November 2009 when Google acquired the company for $750m in shares. With the usage of AdMob app developers can monetize their application for mobile devices across all operating systems (e.g. Android, iOS, etc.). In 2017, AdSense was the most used monetization platform with it being used on 59.59% of apps installed on smartphones. With the closest competitor being Facebook whose mobile monetization platform is used on 28.63% of apps installed. Some app developers use more than one monetization platform for their apps.

We estimate for Google Display of 16%. The margin is compared to the other three segments low (see Exhibit 6). The reason for this are the additional TAC (i.e. the revenue shares paid to ad publishers). Furthermore, we estimated that the Cost-per-Click is at $0.58 in 2017, which is an estimate given by the website Adstage.com. We expect the CPC to slightly decrease in the future and predict that it will be around $0.42 in 2022. Among other things, the decrease can be explained by the fact that Facebook is a market share threatening substitute for Google Display (more details on this in the segment analysis). Our estimated decrease is also in line with the internet ad spending forecast of eMarketer which estimated a total spending of $26,137bn in 2017 and of $18748.1bn in 2022 which results in a CAGR of -6% for the period 2017-2022. As part of our Google Display valuation model, we have also estimated the number of clicks on ads. Our estimate gave a click count of over 30 million in 2017; this translates to a CAGR of 16% for the 2014-2017 period. Driven by the worldwide increasing internet penetration rate and the improvement of Google’s ad placement

178.1

205.4

258.2

2017 2018* 2022* Exhibit 14: Number of mobile apps downloads (in billions) (Source: Statista.com)

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algorithms (i.e. the ability to deliver more relevant ads to potential customers) we estimate an increase in clicks on ads between 80% and 90% until 2022.

▪ YouTube

YouTube is a video-sharing platform founded in 2005 by three former PayPal employees. Initially, it was an independent company but got acquired by Google just one year later in October 2006 for $1.65bn. Today YouTube is the biggest video-sharing platform in the world with over 5bn views daily (Source: omnicoreagency.com/youtube-statistics/) and 30m daily active users. In 2016, YouTube was able to claim a market share of 79% on the US multimedia market. Google’s monetization strategy of YouTube is slightly different than on its other properties. The ads products are also sold over the Google Ads platform. Also, Google sells search text ads (popping up on the video search results) and in-display text ads (showing up at the right side while watching a video). However, instead of displaying traditional text ads exclusively Google introduced in 2014 a new ads product called TrueView Ads. TrueView Ads give advertisers the opportunity to let their ads been displayed before, during or at the end of a YouTube video. These advertisements appear in the form of a short video to the viewer.

The average Cost-per-Click for ads on YouTube was according to estimates around $4.48 in Q4 2017 (Source: AdStage) is comparatively high and can be explained by the fact that this form of advertising is more appealing and draws more attention of the viewer than the other ads products of Google. Furthermore, it must be considered that the user behavior on YouTube is more interesting for advertisers. Google Search may have more visits per month, but people spend significantly more time on YouTube, which lets them exposed to ads for a more extended period. According to our calculations and numbers from similarweb.com a user spends on average 35% more time on youtube.com than on google.com and 98% more time than on facebook.com. Finally, one has to consider that 55% of the TrueView ads revenue goes to the video creator. All those factors push the Cost-per-Click up. We forecast that the average CPC for ads on YouTube will continue to rise and will reach up to $12.11 in the year 2022. Our forecast is supported by internet ad spending forecast taken from eMarketer. They estimate that advertisers will increase their ad spending on online video platforms from $22910.6bn in 2017 to promising $61909.8bn in 2022.

The valuation model for YouTube also takes into account the Monthly Active Users (MAU) on YouTube. MAU have risen continuously over the last 4 years, with a sharper jump of 26% from 2016 to 2017. Regarding geography, in 2017, 15% of all MAU were from Europe, 20% from North America, 50% from

Asia-43,37 bn 24,43 bn 22,15 bn 9,05 21,7 12,05 Google Search YouTube Facebook Monthly visits Avg. visit duration Exhibit 16: Monthly visits in bn & average visit duration in minutes (Source: similarweb.com)

79% YouTube Netflix Hulu bing Videos Others

Exhibit 17: MAU on YouTube in mio. (Source: Euromonitor) Exhibit 15: Market share multimedia websites in the US in 2016

676 750 947

1092

12311346

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Pacific (APAC) and 15% from the Rest of the World (RotW). We expect that APAC and in the RotW (i.e. Africa, South America) will be the essential MAU growth drivers in the future, as Europe and North America appear to be in a more mature stage with growth rates, in 2017, of 11% in Europe and 3% in North America. In comparison, APAC had a MAU growth of 46% in 2017 and the RotW of 26%. In India, for example, the MAU exploded from 70m in 2016 to 190m in 2017, corresponding to a 171% increase. YouTube’s sharp growth in India has been led by the rollout of easily affordable mobile internet plans. In 2017, the internet penetration rate in Africa, APAC, and the Middle East were 21.8%, 43,9% and 43.7%, respectively (Source: Statista.com). We deduce from this, that the increasing internet penetration in geographic areas like Africa, APAC and the RotW will eventually lead to increasing MAU on YouTube.

In our opinion, YouTube bears great future potential, and we expect it to become an essential driver of Alphabet’s future success. Currently, it is analyst consensus that YouTube barely breaks even, with an estimated EBITDA margin of only 6% (see Exhibit 6). In a conference call from Q1 2015 Alphabet explained that YouTube could become profitable ‘tomorrow morning’ by simply putting on ‘the brakes’ on YouTube’s growth. We expect that the growth strategy will pay off in the next few years, when MAU growth will start to reach its limits and with Alphabet, eventually, switching focus to YouTube’s profitability.

Other value driving units

The four companies mentioned may have been business successes as stand-alone entities. However, our analysis of the business model led us to the conclusion that Alphabet’s consistent outstanding financial performance is also driven by several supplementary business units, which at first sight may appear of less importance from a financial standpoint. Those business units tend to add value in an unconventional way. Some of them bear promising future revenue streams, and other units again work in the background. In our opinion, the combination of all these units generates an unbeatable positioning in several markets. Alphabet has succeeded in creating unique synergies through the interplay between advertising sales, free services, and products, and cutting-edge research & development. This is why we spent extensive time analyzing the business units besides the four aforementioned major platforms.

▪ From the Google segment

Google has several other products in its portfolio. In our opinion, these products can be grouped into three categories. The first category contains products with their separate revenue stream (e.g. Google Cloud Platform) and which especially Exhibit 19: Revenue model for

YouTube 12 15 19 24 30 23% 29% 27% 22%

2016 2017 2018E 2019E 2020E Exhibit 18: Average revenue per user on YouTube (in $) and YoY growth rates (Source: Euromonitor)

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in the future bear growth potential. The second category contains products which function as complementary to Google’s main products (e.g. Google Sheets, Google Mail). Lastly, products which are mainly used as vehicles to extend the reach and facilitate the use of Google’s primary revenue generating products (e.g. Android, Google Hardware) can be conflated into the third category. Google owns and operates hundreds of other soft- & hardware products. However, we will focus on the most relevant for the business model and, for our evaluation of Alphabet’s future potential.

In the first category, we identified Google Play and Google Cloud Platform as two products with promising growth prospects.

Google Play:

S

tarted as the place where Android OS users could download and access apps for their devices, but over the years it developed to an extensive online-entertainment hub with a similar offering and business strategy as Apple’s iTunes. With Android’s estimated market share of 84.8% for mobile operating systems (vs. iOS 15.1%) and 66.7bn app downloads (vs. iOS 27.8bn), and an estimated revenue of $7.2bn in 2017 (Source: Morgan Stanley), we consider Google Play to be an essential business unit. One has to keep in mind that Google Play not only generates revenue directly through the sales of apps, movies, subscription, etc. but also indirectly as it is factually the vehicle which delivers apps to Android device users. Those apps will most probably use Google’s monetization platform AdMob, and adds to Google Display’s revenues. For the future, we expect that Google Play will continue to grow driven by the increasing market penetration of smartphones. We see Google Play at an advantage over Apple’s iTunes regarding growth prospects as the strongest growing markets for smartphones currently are emerging markets (India, Indonesia, and South America). With the comparably low purchasing power in those countries, we expect that smartphones with Android will be more appealing to the local customers, as it is possible to run Android also on lower-budget smartphones. Our prediction is also supported through smartphone market data from India in 2018 where Apple holds a marginal market share of 1%. In this context, we think that Google Play is a promising product which in the future could develop to a meaningful revenue stream outside of the internet ad business.

Google Cloud Platform (GCP): The next product we consider to bear significant

future potential is GCP. GCP offers Infrastructure as a Service (IaaS), Platform as a Service (PaaS), and serverless computing environments. According to a market analysis by gartner.com GCP’s revenue grew by 312% in just two years (CAGR of 76.64%) in the IaaS segment alone. In a conference call in early 2018 Google CEO Sundar Pichai disclosed that GCP is already generating around 29% 28% 20% 12% 10% 1% Samsung Xiaomi Others Vivo Oppo Apple Exhibit 20: Smartphone market shares in India Q2 2018 (Source: Statista)

Exhibit 21: GPC revenue in the IaaS segment (Source: Gartner.com)

250

500

780

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$1bn in revenue per quarter. In another earnings call in October 2018 Alphabet explained that they see GCP as a priority area where they will continue to invest in and raise headcount heavily. Alphabet’s investment activity leads to a YoY increase of 26% in operating expenditures, explained Alphabet in the earnings call. For this reason, we believe that GCP currently operates on a lower margin than its peers (e.g. Amazon’s AWS or Microsoft’s Azure). However, we consider that the massive investments i n GCP will continue to be the correct decision in the current competitive market environment, where currently Alphabet lies far behind Amazon and Microsoft. We consider the cloud market to be still in its early years bearing substantial future potential. A forecast from Wikibon.com for the public cloud market states that until 2027 the market volume will amount to $552bn (vs. $154bn in 2017), this corresponds to a CAGR of 13.6% for the period 2017-2027.

In the second category, we consider Google Mail (=Gmail) and Google Maps (=Gmaps) as another two essential business units to Alphabet’s business model.

Google Mail: Gmail is a free e-mail service developed by Google. Since its

public launch in the summer of 2009 Google Mail quickly became the most popular e-mail service worldwide. While in June 2012 Google announced that Gmail had around 425 million active users worldwide this swiftly began to increase over 900m active users in May 2015 to 1.2bn active users in July 2017. The e-mail platform is to a moderate extent monetized by displaying text ads and by offering a paid version of Gmail for professional use. We expect that Alphabet will focus on pushing forward the sales of the paid version in the next few years. Our expectation is also supported by the decision of Alphabet in 2017 to stop the gathering and extraction of data from users’ e-mail traffic, to win the trust of corporate clients that their data is kept private. However, despite the moderate monetization strategy of Gmail, we do not expect it to become a significant revenue generator in the next few years. The e-mail market is already a mature and well-saturated market. Nevertheless, we regard Gmail as an indirect value generator. Its function is to lock in users in the long run in Google’s ecosystem and getting them to use Google’s other products.

Google Maps: As the second mention-worthy product, we identified Gmaps.

Gmaps is Alphabet’s web mapping service offering satellite imagery, real-time traffic information, and route planning. Similar to Gmail, Gmaps is also to some extent monetized. Alphabet generates revenue with Gmaps by displaying ads, for example, if someone is looking for a restaurant in a particular city. Gmaps will then display a paid ad from a restaurant in that area. Gmaps second revenue stream is the sale of a Google Maps API, which allows third-parties to implement Gmaps’ framework and database in their services and apps. A paid subscription

0.350.43 0.9 1 1.2 1.5 Jan 12 Jun 12 May 15 Feb 16 Jul 17 Oct 18 Exhibit 23: Worldwide active user on Gmail in bn (Source: Company Data, Analyst Estimate)

12.2 3.1 1.1 _0.78 6.4 A maz o n Mi cro so ft A lib ab a G o o gl e O th e rs

Exhibit 22: Revenues distribution by vendor on the IaaS market worldwide in 2017 (in bn $) (Source: Gartner.com)

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is offered which then enables access to the full functionality of the Gmaps API. We acknowledge Gmaps revenue generating capability. However, we think that Gmaps is of much higher value as a complementary product. Its synergies with the Android OS are tremendous turning smartphones into fully functional navigation devices. Moreover, it generates tracking data, which is highly valuable for Alphabet’s targeted advertising products. Finally, we consider the synergies with Waymo as valuable. Gmaps provides Waymo with a sound basis for the development of highly detailed maps for self-driving cars. In addition, Gmaps offers Waymo a huge amount of real-time traffic data that can improve the development of self-driving technology.

Android: In the last category, notably, the acquisition and development of

Android Inc. in 2005 was a groundbreaking strategic decision. Today the Android OS is run on 84.8% of all mobile devices and is the most used operating system across all device types (stationary & mobile). And future trends are in favor of Android as the most interesting mobile device markets in the next few years are emerging markets like India and Indonesia, where people prefer affordable, lower-budget phones running Android OS (see Exhibit 20). Alphabet’s distribution strategy is unique, practically offering the operating system for free. The device manufacturers have to enter licensing contracts with Alphabet to be allowed to use Android as the operating system on their manufactured devices. Until recently, these agreements also stipulated that the Android OS comes with a range of pre-installed Google products and that modifications which would threaten the compatibility with Google products were disallowed. In this way, Google Search, Google Play, Google Maps, and other Google products were already deeply implemented in the operating system and not alterable. These contractual collaborations enabled Alphabet to place its products on the entire smartphone market without ever having to build a phone. The dominance of Android OS in the smartphone market paved the way for the explosive growth of Google Search Mobile and Google Play. Also, it supported YouTube’s dominance in the online multimedia market. It allowed Alphabet to market a whole universe of its products in a highly potent and cost-effective way. In our opinion, this is an unbeatable positioning of its products, through which Alphabet can gather massive amounts of user data and can generate revenue extensively through ad placement in their Google products. We regard Android OS as a key puzzle piece to Alphabet’s current success, despite not generating revenue itself. However, very recently there was an impactful incident. Recently, Alphabet had suffered a significant setback, when the EU sentenced Alphabet to pay a fine of $5.07bn. The European authorities identified anticompetitive behavior in connection with Android. In specific, the pre-installment of Google products and 84.8%

15.1% 0.1%

Android iOS Others Exhibit 24: Mobile phone operating system worldwide in 2018

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the disallowance of certain alternation raised complaints by competitors and led to the filing of an anticompetitive lawsuit, which was decided to the detriment of Alphabet. To avoid further legal problems Alphabet decided to implement in October 2018 changes its Android licensing model. The core of Android will remain cost-free and available for licensing by device manufacturers. However, the new licensing model plans to charge up to $40 per device for the Google products bundle. Purchasers can offset the fee by getting a share of the revenue when placing the Google products in a salient position. Despite the fine impacting the financial result in 2018 perceptibly, our opinion is that under the current circumstances the verdict will not have lasting strategic implications or an impact on Alphabet’s current market positioning. The market shares and the importance of the Google products as part of the Android OS is already indispensable.

▪

From the Other Bets segment

Waymo: Besides Alphabet’s current four major profit drivers, we also considered it appropriate to separately forecast the future revenue streams generated by the self-driving technology development company Waymo. The company is the current major success of Alphabet’s R&D company ‘X’. Waymo develops technology for autonomous driving. In collaboration with car makers like Fiat-Chrysler Automobiles (FCA) and Jaguar, Waymo’s purpose is to assemble fleets of 100% autonomous vehicles. Until very recently Waymo had a test fleet size of 600 Chrysler Pacifista minivans driving in several cities mostly in the western part of America. In the focus of interest currently is the city Phoenix, where in December 2018 Waymo launched its first commercial robot-taxi service. It is current expert consensus that Waymo’s self-driving technology is market leading. Data collected by the Departure of Motor Vehicles in Califorinia gives a hint about the size of Waymo’s competitive edge (see Exhibit 25 and 27). From September 2014 untilNovember 2017, Waymo had reported over 1.4m miles driven. The AV competitors altogether reported in total 200k miles driven in the same period of time. In Exhibit 12 is depicted how many interceptions by a safety driver where necessary on average per 1000 miles. While improvements were made on both sides the self-driving units equipped with Waymo’s technology needed on average only 0.18 interceptions per 1000 miles whereas others’ technology on average 14 interceptions per 1000 miles. While testing in other states does happen the statistics give a good, first idea about Waymo’s advantage. Worlwide Waymo 10m mark of test miles driven in October 2018. In order to forecast the revenue of Waymo, we decided to split it into three segments. The first segment is the robot-taxi service, the second segment is the logistics service, and the last segment is the licensing business of the AV technology.

Exhibit 25: Thousand miles driven in California from 09.2014 until the 11.2017 (Source: DMV, UBS)

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Robot-taxi service: Waymo’s robot-taxi service is its furthest advanced project

of all. The service is comparable with the ride-hailing services of Uber and Lyft, but with the big difference that no physical drivers should exist. Although Uber is the current market leader on the ride-hailing market and also works on its own solution for driverless cars, it is still far behind Waymo’s state of progress according to a report on AV by UBS. Since April 2017 Waymo launched a test phase in the city Phoenix where it allowed 400 selected people to use the ride-hailing service for free. After 1 ½ year of gathering feedback from the test users, Waymo launched the first commercial service in December 2018 again in Phoenix. To forecast the revenue of the robot-taxi service, we estimated that Waymo will operate a fleet size of 1.2m cars in 2030, which translates into a CAGR of 86% for this period. We have based our estimations on the already known number of cars ordered. For example, in 2018 Waymo disclosed that they closed a deal with FAC on the delivery of 62,000 cars in the next few years and with Jaguar a deal for further 20,000 cars. Furthermore, we assumed that the cars in the fleet will drive on average 25.2k miles per year (vs. 18k miles in 2018), due to the improved utilization of the service. We estimate that in 2030 Waymo will break the 30bn mark of miles driven in Waymo cars. Based on analyst consensus (Morgan Stanley, UBS) we estimate that Waymo currently charges on average $0.9 per mile. In 2030 we expect that the price per mile will be slashed in half to $0.45 per mile, due to scale effects, increased production efficiency and increased competition. With the value driving variables now set, we forecasted that in 2030 Waymo will reach an annual revenue of $13.8bn. The estimated long-term operating margin for this segment is 12% (Source: Morgan Stanley).

Logistics: Waymo initialized years ago the first tests of self-driving trucks on the

streets of California and Arizona. In the Q2 earnings call of 2018 Alphabet reaffirmed that Waymo plans to continue exploring the logistics market to identify future commercial opportunities. The very same month Waymo launched a pilot project in Atlanta. As part of the pilot project, Waymo's automated trucks carried out first deliveries for Google's nearby data centers. We expect Waymo to have a significant the complete logistics market including the short haul transportation segment as well as the long haul transportation market. Analyzing Waymo’s value proposition led us to the conclusion that Waymo will be able to offer its services to much lower operating costs thanks to higher utilization of its trucks (less time spent in breaks), lower overhead costs, and reduced insurance costs by cutting error fares (Source: PwC Strategy&). Morgan Stanley estimated for the year 2030 that Waymo’s logistics segment could generate $84bn in revenue. We calculated based on this estimate a CAGR of around 49% until 2030 and used this to forecast Waymo’s revenue in the logistics segment. We consider the

0.5 76 0.2 106 0.18 14 Waymo Others 2015 2016 2017 Exhibit 27: Number of

disengagements per 1000 Miles (Source: DMV, UBS) m 2m 4m 6m 8m 10m 12m 01.2015 10.2015 07.2016 04.2017 01.2018 10.2018 10m in Oct 2018 Exhibit 26: Waymo miles driven worldwide (Source: Company Data)

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logistics market to bear more value potential than the ride-hailing market. However, we expect that Waymo will need more time to fully unfold its potential in this segment as we expect that they will first attempt to prove their AV concept in the robot-taxo segment. Regarding operating margins we expect them also to stabilize around 12% by 2040 (Source: Morgan Stanley).

Licensing: Waymo already entered partnerships with big car manufacturers like

FCA and Jaguar, and we can imagine that Waymo could also generate additional profit by letting car manufacturers pay licensing fees in exchange for the usage of its autonomous technology and software. We consider the operating costs for this segment to be minimal. Furthermore, the licensing model would allow easy scalability. However, we expect that Waymo will only launch a licensing service if the already more progressed projects like ride-hailing and logistics prove to be successes and the production costs of the AV systems diminish. Currently, the cost to produce the autonomous driving technology is too high and would push up the price for end-users out of the range of their willingness to pay. UBS estimated in its newest report on AV that currently an AV system costs around $100k but that they expect that the costs will drop below $10k already in 2025. Only then we think Waymo will start to consider offering their systems to car manufacturers in exchange for licensing fees. This is the reason why we set 2024 as the first year where Waymo will generate revenue in its licensing segment. Morgan Stanley estimated for 2030 that the revenue in Waymo’s licensing segment could reach $149m. We used this to calculate a CAGR from 2024 until 2030 of around 130%. We see the licensing segment as very interesting as it bears recurring, stable and high-margin revenue streams.

Overall, we are excited to see how Waymo will develop in the next few years. Currently, it is at its most crucial business development point. It is starting its first commercial services and is massively scaling up its size and reach. However, we think it is perfectly prepared to overcome future challenges as they are fully backed up by Alphabet. We also expect that Alphabet will implement even more creative monetization strategies than the aforementioned. For example, Alphabet could generate additional revenue for its ads segment by offering ad space on its car fleets. The ride-hailing fleet as well the logistics trucks offer a lot of potential ad space. We consider the implementation of ads on Waymo’s fleet highly likely, as the ad selling company ‘Firefly’ already does successfully display ads on the cars of Uber and Lyft. However, Firefly pays a large share of the generated revenue back to the car driver. This, of course, will not apply to the self-driving fleet of Waymo, thus, widening further the profit margins of Waymo for Alphabet. Also, we consider it likely that Alphabet will enter several more strategic partnerships with car manufacturers, ride-hailing companies like Uber & Lyft and Exhibit 28: Estimated revenue of

Waymo for the year 2028 (Source: Analyst estimates)

5.587

37.533

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logistics companies as the company matures of the next decade. Some experts suggest that Waymo could focus only on the AV operating system leaving the hardware production and implementation to partners like car manufacturers. Furthermore, they suggest that Waymo could offer its AV operating system for free similar to their business practice with Android. The rationale behind it would be similar as well. They would offer the AV operating system for free in order to maximize the reach of their software and at the same time would heavily monetize the in-car experience by displaying ads and bringing users to use Alphabet’s products. Because of various reasons, we consider the probability of this scenario occurring as very low for now. First, Waymo currently has not only a competitive advantage in developing the AV operating system but also in developing the necessary hardware to transform cars into autonomous vehicles. It would make no sense to not capitalize on this competitive advantage by continuing to produce also the hardware and selling it to customers. Second, Alphabet/Waymo has a first-mover advantage in the ride-hailing market with AV technology. Just this month they launched their commercial service publicly. They will continue to capitalize on this by progressing with their ride-hailing project. In addition, no other company on the market is as advanced as Waymo, while at that time on the mobile phone market Alphabet had to catch up with top dogs such as Microsoft, Apple, and Nokia. Our strategic analysis is also confirmed by a UBS report on Waymo & AV.

Key Risks

Alphabet’s performance over the years was consistently outstanding. Following our analysis, we expect that Alphabet will continue its success story. However, it is important also to acknowledge that risks exist, which could undermine our analysis and inferred conclusions.

Low returns on ongoing investments: Several investments of Alphabet,

especially in the Other Bets segment, continue to irritate investors, as a lot of them appear to be very experimental projects which lack potential of profitability. At present, investors are still satisfied with the situation, despite those investments dragging down margins. Especially the impending commercial launch of Waymo has helped to maintain investors’ trust over investments in the ‘Other Bets’ segments. However, if further commercial successes fail to materialize in the future, Alphabet's current investment strategy could negatively impact the enterprise value.

Market sensitivity: After the burst of the dot.com bubble in 2001 investors

nowadays are a lot more cautious when investing in companies from the tech industry. Small signs of bad news or hints of deteriorating prospects can lead to

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sensitive investor reaction and can have a negative impact on Alphabet’s equity value. For example, In March 2018 the news about the Cambridge Analytica data breach at Facebook had a severe impact on Alphabet’s stock price and market cap. While the scandal was unfolding, and Facebook’s stock price heavily dropped it also significantly impacted Alphabet as they lost $94.5bn of market capitalization (-12,64% of its total market cap) between 15th _{of March and the 3}rd

of April.

Deterioration in the ad market: Alphabet’s business model and profitability

massively rely on advertising. In 2017 86% of its revenue came from Google’s advertising business. Despite efforts to reduce the reliance on ad selling, Alphabet will remain heavily dependent on its advertisers, digital publisher, and corporate partners. Expenditures by advertisers tend to be cyclical. An economic slowdown would most certainly lead to reduced budgets of advertisers, which would adversely affect Alphabet’s revenues and advertising business.

New competitors: Alphabet’s business environment is rapidly evolving, and

subject to ever-changing technologies, shifting customer & user needs, and frequent introductions of new products and services. In order to compete successfully, Alphabet must respond successfully to these changes. Alphabet must continue to invest significant resources in research and development, including through acquisitions, in order to improve their technology and products and to introduce new technology and products. As technologies continue to develop, competitors may be able to offer extensively similar or better user experiences than Alphabet can offer. If competitors are more successful in developing compelling products or in attracting and retaining users and advertisers, revenues and operating results could be negatively affected.

Government actions: Violation of privacy, exploitation of tax loopholes, and

anti-competitive behavior are some of the many allegations Alphabet is accused of regularly. In the past, this even led to detailed legal investigations against Alphabet. After incidents like Facebook’s Cambridge Analytica scandal and the recent sentences of Alphabet to pay record fines to European authorities, Alphabet’s legal risk is at an all-time high. Even the risk of breaking up individual business units is not something one can fundamentally rule out. We expect that all companies which rely on users’ data will continue to face an increased risk of unfavorable changes in legal environments all over the world. Finally, the ongoing trade-wars could indirectly affect Alphabet’s advertising business, if they may lead to an economic slowdown.

Brand image: Alphabet’s business depends on strong brands. Global scrutiny

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business success. Alphabet’s brands may be negatively impacted by a number of factors, including, among others, reputational issues, third-party content shared on their platforms, data privacy issues, and product or technical performance failures. If Alphabet is not able to contain those problems, it could lead to users, customers and investors losing trust in Alphabet, thus, negatively impacting the company’s value.

The Sector

Alphabet owns several companies, which in turn are active in various sectors and markets, this makes many sectors and markets relevant for our analysis. In the following part, we will focus on the most relevant sectors for Alphabet’s company success. We consider the following sectors to be of essential importance: 1) The internet advertising sector with its subsegments (Search, Display, Online Video) and 2) the autonomous vehicle market represented by Waymo.

Internet advertising

As in 2017 Alphabet generated 86% of its total revenue in the internet ad market, we consider this sector to be the most important one, and we will spend an extensive amount of time analyzing the current market situation, players and trends. Over the last 6 years, the global internet ad market increased with a CAGR of 18.5% according to Magna Global. Whereas, the traditional ad segment, including the categories TV, Newspaper, and Magazines, shrank with a CAGR of -0.6% for the period 2011-2017. In absolute numbers, the internet ad segment became the largest ad market in 2017 when it finally surpassed the TV ad segment. The subdivision of the advertising market in the year 2017 is shown in Exhibit 29. As one can see the internet ad market amounted to $208bn, closely followed by the TV ad market with $178bn. One can easily see, that internet advertising, where Alphabet is almost exclusively operating, is substantially increasing in importance. Lower costs compared to other ad segments, superior targetting possibilities (user data driven targetting, data analytics services, etc.) and a growing reachable user base (especially in emerging markets) mainly drive the growing success of the internet ad market and are enticing advertisers away from the traditional channels. In the future, we expect that the growth of the internet ad market will continue and traditional advertising channel will continue to lose importance except for TV. Our view is also supported by the ad market forecasts of Magna Global. They calculated that for the period between 2017 and 2022 one can expect a CAGR of -1.6% for the traditional ad channels and a CAGR of 10.6% for the internet ads market. However, it is important to remark that the current consensus is that regarding growth rates the internet market 48% 13% 22% 11% 6% Search Display Social Online Video Other

Exhibit 29: Internet ad spend % breakdown in 2017 (Source: Magna Global)

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already reached its peak and therefore it is expected that growth rates will slowly start to flatten out in the long run.

Google & Facebook Duopoly: As depicted in Exhibit 31 in 2017 Google owned

a 59% share of the internet ad market (excl. China). Facebook on the other hand owned further 25% of the internet ad market. This means that the two biggest players together owned 84% of the internet ad market. Google is dominating the ad business with Facebook being currently its only serious competitor. In our opinion, which is also in line with analyst consensus, these two companies have a serious grip on the ad business and own a duopoly. Our opinion is further supported by the fact that by looking at Exhibit 32 in the Appendix one can see that it additionally looks like that they are not taking revenue away from each other, but rather from the other already outpaced competitors, as the market shares of both companies over the years increased. They might compete in some areas like video advertising, but besides that, most of their business is complementary (Search Engine vs. Social Network). Advertisers tend to advertise with Facebook ads as well as with Google ads. Forward-looking we expect that Facebook and Alphabet will continue to dominate the internet ad market, but we can see that new competitors could slow down their growth. Possible reasons could be Amazon’s plans to increase its engagement in the internet ad market or Snapchat’s growth.

According to our estimates, Google generated with its search engine ads 56.9% of Alphabet’s total revenue in 2017. Out of the total amount spent on internet advertising in 2017 $113bn (47.9%) was spent on search advertising. Since 2011 the search advertising market grew with a CAGR of 18.8%. Here, the growth was 59% 25% 5% 3% 8% Google Facebook Microsoft Yahoo Others

Exhibit 31: Internet ad market shares (excl. China) in 2017 (Source: Magna Global)

Global (in m $)

2018

2019

2020

2021

2022

Internet Ad Spending 236,769 263,937 291,254 319,403 347,720

y/y growth 13% 11% 10% 10% 9%

Advertising Spending 534,786 553,898 581,039 601,180 629,530

Internet Share 44% 48% 50% 53% 55%

Exhibit 30: Internet ad spending overview (Source: Magna Global)

Exhibit 32: Market share development on the internet ads market (Source: Magna Global)

14% 56% 26% 4% _2% 20% 19% 58% 19% 3% _2% 13% 25% 59% 11% 3% 3% 6%

Facebook Alphabet Microsoft Yahoo Twitter Others 2015 2016 2017

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Alphabet delivers alpha

Strong growth & dominating market position

Table of Contents

Alphabet Inc - Valuation

The Sector

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Financials

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Valuation

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Appendix

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Alphabet Inc - Valuation Summary

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Company Overview

Shareholder structure

Core Strategy

▪ Google LLC

Alphabet’s major profit drivers

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▪ Google Search Desktop & Mobile

▪ Google Display

▪ YouTube

Other value driving units

▪ From the Google segment

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From the Other Bets segment

Key Risks

The Sector

Internet advertising

Global (in m $)

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