New Position: Alphabet (GOOGL, Financial)
Third Point initiated a position in GOOGL during the First Quarter. Fears around the potentially negative impact that AI and ChatGPT/MSFT may have on GOOGL’s business created a unique entry point into one of the best consumer internet assets and businesses of our generation.
While ChatGPT has unquestionably captured the general public’s attention (as well as several hundred million users), we believe the market underestimates GOOGL’s own capabilities and opportunities in the emerging field of generative AI. GOOGL has been a leader in the broad field of AI for years, with the company’s scientists pioneering several of the software and hardware innovations that underpin current advances, most notably the Transformer architecture in 2017 that served as a key building block for GPT-3. Fruits of these investments were visible at last week’s developer conference, Google I/O, where GOOGL previewed their latest large language model (LLM) and an impressive slate of AI-powered product improvements across their Search, Maps, Gmail, Workspace, and Cloud offerings. We believe these new products now put Google on the offensive in the dawning age of AI, allowing it to further grow consumer engagement with Search, make its Workspace products more competitive against Microsoft Office, and differentiate its Cloud offerings to accelerate share gains from AWS and Azure.
We are also encouraged by GOOGL’s commitment to “durably reengineer its cost base” to deliver sustainable and consistent margin expansion for investors. While GOOGL has been more measured than peers when it comes to public headcount reductions, we believe the market underestimates the impact from GOOGL’s other initiatives such as optimizing compute infrastructure, rationalizing its real estate footprint, and leveraging AI to drive automation across the organization. While management has articulated that results of this effort will be most visible in 2024 onwards, the company’s most recent financials already indicate change. Reported headcount additions of 477 in the First Quarter were the lowest in a decade, and growth in operating costs (excluding one-time severance and lease break fees) slowed to 8%, from over 20% just a few quarters ago.
The opportunity to rationalize Google’s cost base cannot be understated. GOOGL’s total costs sum to a staggering $170 billion (excluding traffic acquisition costs), of which we estimate $70 billion comes from full-time equivalent salaries and bonuses, leaving substantial room for improvement across all aspects of the organization. Seventy percent of GOOGL’s revenues come from a business with 90% incremental margins (Search) yet consolidated operating margins last year were only 32%.
While we are pleased to see GOOGL management’s stated plans to reorganize its operations to improve margins, we believe that more is possible, and further improvement should unfold in the coming quarters. We have shared our views on this topic with management, who seem amenable to considering further efficiencies and better deployment of capital. We were also glad to see improvement in the company’s communications around its AI capabilities at the I/O conference, which received significant attention and helped buck the negative narrative that had formed around Google’s status as a technological leader.
From Daniel Loeb (Trades, Portfolio)'s Third Point first-quarter 2023 letter.
