Alphabet’s Uphill Battle: Google’s Bard Struggles Against ChatGPT
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Summary:
- Alphabet struggles with a bloated workforce and an underwhelming chatbot, Bard, in the face of ChatGPT’s rapid growth.
- Restructuring efforts and cost-cutting measures could help Alphabet mitigate the risks posed by emerging competitors.
- The company’s potential for innovation and adaptability makes it an intriguing investment opportunity despite the challenges.
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In January, we penned an optimistic piece on Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), countering the prevalent doom and gloom sentiment in the wake of ChatGPT’s explosive growth. We posited that the fierce competition from OpenAI and Microsoft (MSFT) could galvanize the company to break free from its inertia and innovate at a faster pace. However, as events unfolded, our outlook on Alphabet soured, witnessing the company’s lackluster response to the mounting challenges. Consequently, we shifted our stance from a Buy to a Neutral rating on GOOG stock.
Introducing… Bard?
Like many people, we were not enthusiastic about the name of Google’s new A chatbot, “Bard”, but we were willing to let the results speak for themselves. Unfortunately, the results were even less inspiring than its name.
In response to Microsoft and OpenAI’s onslaught in AI and search, Google responded in February at an event in Paris, where it demonstrated a range of AI enhancements for its search engine, including plans to generate lengthy textual responses to complex queries that do not have a single correct answer, such as “what are the best constellations to look for when stargazing”. This demo followed Google’s recent preview of its own chatbot, Bard, which is a rival to the popular ChatGPT chatbot. Unfortunately, Bard’s preview highlighted the challenges of employing AI tools when it provided an answer containing a factual error, garnering widespread negative publicity.
In our view, Alphabet’s recent “Google Live from Paris” event was underwhelming, not only due to the factual error (which, interestingly, mainstream media overlooked similar errors in New Bing), but also because of the general perception that it fell short compared to Microsoft’s slick presentation, featuring an extensive introduction by the CEO. In contrast, Alphabet’s CEO was conspicuously absent. Furthermore, the company failed to directly address Microsoft’s integration of ChatGPT into Bing search, announced just the day before, highlighting Google’s current predicament.
Last month, we were given access to the experimental version of Bard, which we tested out and were quickly underwhelmed. After testing Bard and ChatGPT, we found that ChatGPT consistently outperforms Bard. Although both systems have their strengths and weaknesses, ChatGPT demonstrates better verbal reasoning, creativity, and overall performance.
ChatGPT excelled in tasks such as providing reliable cake recipes, creating poetry, offering marathon training plans, and solving reasoning problems. On the other hand, Bard often made mistakes and provided less reliable information. Overall, we didn’t find that Bard added any value to users who are already using ChatGPT.
The disappointment in Google’s Bard chatbot has coincided with the ongoing impressive innovation from OpenAI, which recently launched GPT-4 and opened the waitlist for the ChatGPT plugin for users and developers.
Negative media coverage for Bard continues relentlessly. Just this past week, Google publicly denied that its AI search chatbot Bard was trained using text generated by OpenAI’s ChatGPT. This situation arose after AI engineer Jacob Devlin raised concerns that Google might be violating OpenAI’s terms of service by using data from a website called ShareGPT to train its Bard chatbot. Devlin resigned from Google after escalating these concerns to CEO Sundar Pichai and joined OpenAI. In our judgement, this controversy makes Alphabet appear less like a technological leader in AI, as it raises questions about the company’s practices in using data from competitors, potentially leading to awkward situations and ethical concerns.
Lastly, Google’s CFO Ruth Porat recently announced company-wide cost-cutting measures, including reducing employee services and scaling back on office supplies like staplers and tape. These moves come during a period of significant cost cuts for Alphabet-owned Google, which is experiencing slowing sales growth. In our view, although cost-cutting measures can improve financial performance in the short term, comparing the current situation to the 2008 financial crisis and cutting trivial items may create an impression of desperation, making Google seem like a legacy technology company rather than a cutting-edge innovator capable of competing with OpenAI. Such actions may not project the confidence and agility expected from a leading technology firm.
Financial & Valuation
In our financial analysis of Alphabet, we note that the company’s revenue growth decelerated significantly in 2022, posting a 9.8% YoY growth to $282.8 billion. This is a stark contrast from the 41.2% growth witnessed in 2021, which was significantly above its long-term growth rate of around 20% over the past decade. International markets experienced a sharper deceleration due to foreign currency headwinds.
The consensus estimates for 2023 project a further deceleration of revenue growth to 5.4% before accelerating to 11.5% in 2024. This is primarily driven by a broad-based slowdown in advertisement spending in a weakened macro environment and difficult comparisons, both in advertisement and cloud spending in 2021.
Operating expenses outpaced revenue growth in 2021, causing earnings per share to decline by 19% YoY to $4.56. Despite the expected further topline deceleration in 2023, EPS is projected to rebound by 12.5% as the company restructures its cost structure for the new environment. Consensus forecasts expect continued acceleration in earnings in 2024, with an increase of 18.9% to $6.10.
However, we note that consensus estimates likely forecast only a modest slowdown in the macroeconomic environment and immaterial share losses in advertisement to competitors, particularly Microsoft. These factors represent the most significant downside risks to the company’s shares.
On the other hand, if Alphabet becomes more aggressive on cost-cutting as the CFO recently suggested, the company could beat these expectations in the short run. Currently, Alphabet is trading at the lower end of its 10-year multiple on a price to forward 12-month EPS at 19.3 times P/E. Relative to the S&P 500, Alphabet is trading at a 9% premium on the P/E metric, which is also towards the lower end of its 10-year range.
We believe Alphabet is attractively valued. However, the company faces an unprecedented challenge to its business model with the emergence of ChatGPT and the new Bing. Despite the potential risks, Alphabet’s recent restructuring efforts and focus on cost-cutting may provide a buffer against these threats, making the company an interesting investment opportunity to consider.
Thesis Risks
Based on our due diligence, it appears that Alphabet’s employee structure may have become bloated, similar to that of Meta. We have received reports that the company has numerous employees whose productivity is not at its full potential. This situation, if proven accurate, could provide Alphabet with an opportunity to reduce its workforce and enhance efficiency. While it is challenging to quantify the extent of this issue, we believe it represents a significant risk to our downgrade of Alphabet’s shares to neutral.
In addition, Alphabet’s potential for innovation must not be overlooked. The company is actively working on addressing the challenges posed by advanced AI technologies such as ChatGPT. It is possible that Alphabet could introduce more innovative and competitive AI products in the near future, only taking longer than we previously anticipated. Should Alphabet successfully introduce groundbreaking AI products, the company could unlock new monetization opportunities for these AI-powered solutions. This could lead to a significant boost in revenue and market share, ultimately strengthening the company’s position in the AI industry.
Conclusion
Despite the considerable challenges Alphabet faces, such as its bloated workforce and Bard’s disappointing performance, the company retains its innovative potential. By focusing on restructuring and cost-cutting, Alphabet may counter the emerging threats posed by competitors like ChatGPT and the new Bing. While Alphabet is an intriguing investment opportunity due to its ability to adapt and innovate, potentially unlocking new monetization channels for AI-powered products and strengthening its AI industry position, we must also consider the company’s lackluster response to these challenges and the worsening macroeconomic environment that could further strain advertisement spending. In light of the unprecedented obstacles ahead, we adopt a neutral stance on Alphabet’s stock, despite its attractive valuation and merits.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
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