Buy Microsoft To Hedge Against Google Antitrust Defeat

Summary:

• With the antitrust ruling against Google last Monday and the next phase to determine remedies, the road ahead is unclear given that the monopolistic company also offers the best product.
• Potential remedies include banning the default search slot for browsers from being sold, only allowing bids from secondary players, making Google’s search data publicly available, and forced restructuring.
• In most of these scenarios, Google’s loss is Microsoft’s gain, making Microsoft the perfect hedge against the fallout from Google’s antitrust defeat.
• Although Microsoft stands to benefit, the case will take years to resolve.
• As the arguably safest and most reliable Mag 7 stock, Microsoft, at 13% off its high, is a great buy regardless of hedge potential.

Last Monday, US District Judge Amit Mehta ruled against Google (GOOG) (GOOGL) in a long-running antitrust suit brought by the Justice Department, stating: “After having carefully considered and weighed the witness testimony and evidence, the court reaches the following conclusion: Google is a monopolist, and it has acted as one to maintain its monopoly.” Judge Mehta found Google to have a monopoly in text search ads (which is not illegal) and abused its monopolistic position through revenue share agreements with major browser providers like Apple (AAPL) and Mozilla to lock in its search engine as the default on their browsers (which is illegal by the Sherman Act of 1890). With the first phase of the suit now completed, the next round begins in September: Bloomberg Law reports that Mehta “ordered the parties to submit a joint proposed schedule by Sept. 4 to address remedies for the antitrust violations he found.”

Google stock fell immediately following the ruling, only to rebound over the next few days, so it seems the market is still weighing what it means for the company’s future. Mike Masnick of Techdirt argues that Judge Mehta is stuck between a rock and a hard place when it comes to potential remedies: Google may be a monopoly, but it still offers the best web search product for consumers.

With Google’s search business becoming a giant question mark, the only surefire winner of the ruling appears to be Microsoft (NASDAQ:MSFT), whose Bing search engine is currently the only viable competitor to Google as the government seeks to open the field to more competition. Microsoft CFO Amy Hood once said that every percentage point of market share Bing can wrest from Google translates into $2B in additional revenue (Bing currently has ~3% global search engine market share, vs. 91% for Google). Microsoft CEO Satya Nadella was a key witness for the Justice Department in the antitrust case, testifying that the anticompetitive forces favoring Google were so insurmountable that even a giant like Microsoft cannot compete.

Investors worried about antitrust remedies against Google can do worse than hedging with a position in Microsoft. Let’s take a look at some potential cures to understand why:

1) No search engine is allowed to pay for the default slot on browsers. Browsers offer users a choice screen upon installation. This would actually be the best possible outcome for Google, since most users would pick Google anyway, and now it would save ~$30B in traffic acquisition payments to browser providers. The argument against this solution would be that the EU already did this back in 2018 (implemented 2021) and Google’s market share remained virtually unchanged.

However, the goal here is not to alter consumer behavior, but to allow potential competitors the opportunity to succeed: since every party in the case ultimately agreed that Google is the best search engine available today, Google can reasonably be expected to retain its market share even after any remedies are enforced. This outcome is still beneficial from a regulatory perspective because it means future rivals only need to beat Google in search quality to convince users to switch over, they don’t also need to beat Google’s ad targeting profitability (it may even open the field for privacy-focused search engines like DuckDuckGo to flourish).

Google profits instantly go up +30%, Mozilla could potentially go bankrupt. No hedge necessary.

2) Google is not allowed to bid for the default slot on browsers, but everyone else is. At first brush, this seems like an unfair and improbable ruling, especially since the likely winning bidder will be Microsoft, a company even larger than Google. However, Judge Mehta noted that “the same conduct can be exclusionary when done by a dominant player, even if it’s not when it’s done by a smaller one,” and Microsoft is absolutely the smaller player in search.

Would it make a difference? During the trial, Apple senior VP Eddy Cue testified that “there’s no price Microsoft could ever offer” that would convince Apple to preload Bing on Safari instead of Google. However, it’s important to note that the “price” search players are offering Apple is not a flat fee, but a revenue share percentage (Google is currently paying Apple 36% of Safari search revenue). That means even 100% revenue share from Bing would be a bad deal for Apple: most of their users would probably change back to Google anyway, and 36% of a large pie is better than 100% of a small one. The calculus changes if Google’s offer is $0: now, 100% revenue share from Bing suddenly seems much more attractive.

Would it be enough to get Apple to switch? Not necessarily, since Apple prioritizes preserving its premium brand image as much as profits (admittedly, a $20-30B bottom-line hit would be painful even to Apple). Even if Apple isn’t swayed to switch to Bing, companies like Samsung (OTCPK:SSNLF) may, and companies like Mozilla will most likely be forced to as a matter of survival. Microsoft wins.

3) Google is forced to open up its search data to competitors. This would potentially be the most interesting remedy, since a large part of why Google became so dominant is because it not only came out of the gate with the superior product, but then also benefitted from having lots of users searching on its platform, observing their behaviors, improving its search algorithms based on this user data, bringing in even more users. This virtuous cycle of “query flow” is such a massive advantage that Satya Nadella cited it as the reason why Microsoft was willing to strip its own branding off Bing and give the whole product to Apple basically for free, losing $15B a year in the process: Nadella believed the search data they get in return would allow Microsoft engineers to rapidly catch up to Google.

Opening up access to Google’s proprietary search data would level the playing field and neutralize one of Google’s most important economic moats. Google’s superior search algorithms would still put it ahead of the pack by several years at least, but now competitors like Bing would have the tools they need to close the gap: whether they actually can would remain to be seen. Winner: Microsoft, as well as smaller search players like DuckDuckGo, Brave Search, and OpenAI’s new SearchGPT.

4) Google is forced to spin off Chrome and/or Android. Expert consensus is that this would be the most severe antitrust remedy, and unlikely. The tricky thing about Google’s internet empire is that search ads pay for everything else: Chrome and Android currently make no money and would likely not survive as independent businesses, in my view. Android could conceivably adapt its business model by charging a licensing fee, but I believe Chrome would be toast. If default slot payments are abolished, the only browsers that will survive are those subsidized by large, profitable parent companies, leaving Apple Safari and Microsoft Edge.

An uncoupling between Android and Google might also encourage Microsoft to invest bigger into mobile, possibly coming up with a new smartphone line running Android OS and preloaded with Microsoft apps like Office, Outlook, Teams, OneDrive, and Edge (kind of like the now-retired Surface Duo line). Winner: Microsoft.

Takeaway

Examining all the scenarios above, Google wins in 1 of them, and in the other 3, Google’s losses are Microsoft’s gains. That means for Google investors, Microsoft is the perfect hedge for a potential antitrust defeat, in my opinion. Of course, the way the real story may play out is not so neat and simple.

There will be appeals, possibly years of them. The ruling may get overturned. Apple may decide to create a search engine of its own to make up for the lost revenue from Google (The Information reported back in 2022 that Apple was at least 4 years away from being ready to launch its own search engine). Microsoft’s step forward and Google’s step back may be negative sum for both companies as margins get squeezed by price wars (Google’s Services division is currently enjoying 35% operating margins), resulting in lower prices for advertisers and consumers: mission accomplished by the Department of Justice.

Microsoft is a great buy anyway, even without hedge considerations, as it has fallen 13% off its high of $468 this year. A big chunk of that dip came as the result of a Q4 earnings report that disappointed investors: cloud growth slightly missed estimates, AI capital investments dragged margins a bit, and there’s still a negative sentiment overhang from the CrowdStrike (CRWD) debacle.

But MSFT is still the most reliable workhorse in the Mag 7, with a higher credit rating than the US Government, double-digit year-over-year growth in both revenue and income, a highly diversified business that spans across intelligent cloud, productivity software, personal computing, and gaming, and a reasonable middle-of-the-pack earnings multiple relative to its Mag 7 cohort. Although the generative AI fervor has been waning recently, Microsoft’s dominance in enterprise means it is still the company that has the best path towards eventual monetization of that technology, making it the perfect portfolio partner to Google (a company that is both potentially enriched and threatened by AI) in a different way.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of MSFT, 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.

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