Google: DOJ Break-Up Deep Dive

Summary:

• Despite DOJ’s antitrust lawsuit, I believe Google shares remain a strong buy due to the company’s valuable assets and potential higher worth if broken up.
• My analysis shows Google’s main revenue drivers, like Google Cloud, YouTube, and Search, are worth more individually, indicating significant upside even if split.
• The DOJ’s proposed remedies, including divesting Chrome and stopping exclusionary agreements, seem like setbacks but won’t drastically harm Google’s overall business.
• With a total valuation of approximately $2.465 trillion, Google’s hidden value suggests the market’s selloff is overblown, presenting a solid buying opportunity.

Co-Authored By Noah Cox and Brock Heilig.

Investment Thesis

Google (NASDAQ:GOOG) (NASDAQ:GOOGL) (NEOE:GOOG:CA) shares are down 2.35% since the last time I wrote on the internet search giant at the end of October after earnings. The price at publication when I last covered Google was $174.72, but shares have since dipped below $170, after reaching a high of $183.32 earlier this month.

A big reason why shares have sold off is because the Department of Justice (DOJ) wants to break up the firm as a part of the lawsuit they have levied against the tech giant. The DOJ alleges the firm is running this business in a way that is monopolistic and harms competition.

While I do think the company will win their critical lawsuit in the long run, I want to talk about why the company is worth more (if it potentially gets broken up) than it is right now, currently in its whole form.

Google has valuable assets that are likely worth more spun out than they are together. With this, I believe shares continue to be a strong buy.

Why I’m Doing Follow-Up Coverage

While this “strong buy” rating is on par with my recent coverage of Google, this follow-up coverage comes with a more nuanced analysis to account for the risk that the firm is broken up.

Each of the last two times I’ve written on Google, I’ve had a “strong buy” rating, I have been less focused on the risks of a DOJ breakup because I have (and still) see this as a low probability event. I think this will be similar to the DOJs attempts to break up Microsoft (MSFT) in the early 2000s. In the end, they lost the appeal and Microsoft stayed intact.

As part of my coverage in September, Google investors (including myself) had just received news of its second antitrust trial of this year brought on by the DOJ.

And as I wrote in my October coverage on the internet giant, earnings for Q3 were fantastic, and any worries that I previously had about Google have really vanished based on what I had seen from earnings.

Now that the market has moved on past earnings (and is fretting about the DOJ breakup), it’s time to take another look at what could potentially happen in this DOJ breakup and how it would affect the company. My goal with this analysis is to show how much each section of Google would be worth if it were on its own (and why the sum of the parts valuation still indicates upside).

The purpose of this lawsuit is to show that I continue to believe the company will win their lawsuit. But even if they don’t, I am doing follow-up coverage to talk about what shares will be worth regardless.

Deep Dive: What Would Happen In a Breakup

For context, the US DOJ kicked off its lawsuit against Google in court earlier this fall, accusing the search giant of monopolizing internet search. In the lawsuit, the DOJ is asking the judge to order Google to spin off the popular web browning app Google Chrome as a remedy for the lawsuit. The DOJ believes this would create a more equal playing field for other search engine competitors.

To remedy these harms, the [Initial Proposed Final Judgment] requires Google to divest Chrome, which will permanently stop Google’s control of this critical search access point and allow rival search engines the ability to access the browser that for many users is a gateway to the internet, the DOJ wrote in a recent filing, according to research by CNBC.

Adding to this proposed remedy, the DOJ is also asking for relief in the form of ordering Google to be prevented from entering into exclusionary agreements with third-party device makers like Apple and Samsung. This remedy would be a setback for the search engine service (in its current form) as it would mean Google can’t pay device makers to make their tech the default search provider on each phone or device when it’s bought. But I do not think overall it will be extremely damaging to the business. ‘Google it’ has become a verb. I find it difficult that consumers will change their habits overnight.

While these requested remedies by the DOJ seem like a major setback for the company as a whole, the purpose of this article is to show how the company is still worth a lot even when they are split up. To understand why, we have to do a deep dive on where revenue is (as of Q3). As of Q3, the tech giant has 3 major revenue drivers (along with less key divisions I’ll dive into below): Google Cloud ($11.4 billion), YouTube advertising ($8.9 billion), and Google Search and other advertising revenue ($49.4 billion). The company has revenue from its ‘other bets division’ (this includes Waymo) but this comes in at just $388 million.

I’ll dive into the valuation of each of the 3 major revenue divisions, but I want to cover what the company’s other specific assets are worth. For example, USA Today reports if the DOJ’s forced sale of Google Chrome goes through, this could be worth up to $20 billion. Waymo was last valued at $45 billion in a funding round in October. Google is estimated to own 70% of them, so this values their stake at $31.5 billion.

Valuation

Normally when I do an asset valuation estimate, I look at the overall company’s EPS or revenue and then extrapolate a multiple off of this. Since there are many different divisions within Google -and each would trade at a different multiple in a breakup- we have to break down their assets to fully understand the company’s true total valuation.

Google is currently the world’s fifth-largest company, according to Forbes -what drives that?

In order to get valuations for each respective division (and then add them to the Waymo and Chrome valuations we talked about before), I think it’s probably easiest to take the most recent quarterly revenue numbers (all based on data from the Q3 Call) and multiply them by four to get the annual revenue total. Then we’ll multiply each division by a specific forward Price/sales ratio.

Starting with Google Cloud’s Q3 revenue of $11.4 billion, extrapolating this out by 4 quarters (and then a price to sales multiple for cloud of 7) equals a total valuation of $319.2 billion. Part of the reason I think it deserves a P/S multiple of 7 is their impressive 35% year-over-year growth as compared to Q3 2023.

On the YouTube side, Q3 revenue came in at $8.92 billion, pegging this division’s valuation at $356.8 billion (this time a price to sales multiple of 10). Keep in mind this is much lower than the forward Price/sales of another social media platform (Reddit (RDDT)) at 18.71. I am bullish on Reddit as well, but the point here is that this P/S multiple is low.

The main driver of Google’s Q3 revenue was search, coming in at $49.4 billion. Here, I am going to apply a more conservative forward P/S of 6.5, creating a total valuation of $1.284.4 trillion. This is below the overall conglomerate’s current TTM P/S of 6.60.

Following this up, we have Subscription platform revenues at $10.7 billion (giving this a forward P/S of 7 for the 28% YoY growth). This comes out to $299.6 billion.

Wrapping this up is Network advertising revenue (revenues from Google-placed ads in non-Google websites). This was $7.5 billion. I am applying a P/S multiple of 3 here since this division saw revenue drop 2% YoY in Q3. This should be worth $90 billion on an annualized basis.

While each of these divisions have revenue seasonality, I believe each division will have higher revenue than Q3’s revenue annualized by the end of next year. So I think these numbers are conservative.

If we add up the valuations of all of these branches of Google, we’re sitting at a total valuation of about $2.35 trillion. But there’s still more to factor in.

As we determined earlier, Google Chrome, if sold, could be worth as much as $20 billion. Add in Waymo as well, and now we’re at $2.402 trillion. Factor in cash on the balance sheet ($93.2 billion) and we arrive at $2.494 trillion.

After adding up all of the company’s assets, we must subtract the total debt. Seeking Alpha pegs this at $29.29 billion as of the end of Q3. Subtracting this total debt from the overall valuation of the company puts Google’s running total valuation at roughly $2.465 trillion.

Then, to get the percent upside of the company as a whole, we’ll divide the $2.465 trillion sum of the parts valuation by the current market cap, which Seeking Alpha puts at $2.08 trillion. This puts total upside for the company at about 18.5%.

Again, while I think the company is the best set left together (it should be worth more than this in the long run) the point of this exercise is to show that the market’s selloff as a result of fears over antitrust proceedings feels overblown.

To address a key possible question: why would individual divisions deserve to trade at higher P/S multiples in the event of a break-up? I believe they should trade at higher multiples due to each of their respective growth profiles.

Google cloud (for example) is growing at a much faster rate than the company as a whole. It should trade well above the company average P/S ratio.

This is very similar to when the US DOJ broke up Standard Oil in 1912. The sum of the parts of the breakup ended up being more valuable than the combined entity.

Risks

While I see the odds of the DOJ breakup going through as low, (see the Microsoft case to understand why these trials rarely hold for firms that are cash rich and determined to stay together), the biggest risk for Google is that these individual divisions aren’t worth as much if they get split up. The reason they could not be worth as much is due to rising competition threatening some of the major lines of business (YouTube and search).

There is a growing (and I think largely unfounded belief) on Wall Street that other AI companies like Perplexity and Open AI will soon pose a legitimate threat to Google’s search engine and lower the value of Google’s division in a breakup. I disagree with this line of reasoning.

As I discussed in my previous research, Perplexity is a semantic search engine. This means that users type a question into Perplexity, and it tries to generate an answer to the question while providing resources (vs source-based options like Google does).

Meanwhile, Google is simply a traditional keyword search engine. While many people do type full sentences into Google, the original intent of their search engine is to type in a series of keywords related to the topic you’re researching, and Google will output a series of websites that match those specific keywords.

Regardless of if Google gets broken up, I think one thing is clear from this biggest risk of semantic search competition: I don’t think keyword search is going away.

Sure, there is a risk that many types of searches can move from Google’s keyword search to a semantic search, but many types of searches still require keywords. This is a space that competitors are not addressing. This is a space that continues to be wide open for Google, regardless of the trial outcome.

Bottom Line

While the DOJ is exercising all levers in their power to push for a break-up of the global internet search giant, (and to their claim even the playing field of the search engine industry) Google’s shareholders should still be in a good place regardless.

We don’t know what the outcome of the lawsuit from the DOJ will be, but my core belief is that Google has hidden value locked in its shares waiting to be extracted. A break-up could result in the quick recognition of this. Obviously, over the long run, the company will be worth more if it stays intact. But I believe that there is a solid short run upside if it’s broken up.

Regardless of the outcome, I am bullish on shares. With this, I think the market is overreacting and shares are still a strong buy.

---

Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOGL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (main account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

---