In spite of its 25% gain so far this year, Alphabet's (GOOGL) stock still appears pretty reasonably-priced when one values the company on a sum-of-the-parts basis.
Currently, the Google parent has an enterprise value (market cap minus net cash) of $791 billion, with the value dropping to $777 billion after accounting for equity investments. That's equal to 21.3 times a consensus 2020 free cash flow (FCF) estimate of $36.5 billion. In and of itself, that's not an awful valuation for a company that's still seeing near-20% revenue growth and owns a host of marquee Internet franchises (including several with dominant, if not monopoly-like, positions).
But the valuation looks a lot better when Alphabet's Other Bets segment, which includes (among other things) the Waymo self-driving unit, the Verily life sciences unit, Google Fiber and Alphabet's investment arms, is a major near-term drag on FCF. Other Bets is expected to post operating losses of about $3.6 billion in 2019 and $3.3 billion in 2020, respectively.
Even after accounting for the tax benefit that Alphabet gets from those losses, the company's 2020 FCF consensus would likely be above $39 billion in 2020 if not for Other Bets' red ink. In such a situation, Alphabet would be trading for around 20 times its expected 2020 FCF.
Of course, such a valuation estimate still doesn't do full justice to Other Bets, since (in spite of the segment's losses) businesses such as Waymo and Verily have considerable positive value. Even if one valued Waymo at just $50 billion (less than half of what Morgan Stanley currently values the business at) and the rest of Other Bets at just $15 billion, that would give Google proper a value of just around 18 times its expected 2020 FCF.
And within Google proper, there are also some valuable businesses that from the looks of things are either losing money in the near-term or earning very little.
The Google Cloud Platform (GCP), the #3 player in the public cloud services space behind Amazon Web Services (AWS) and Microsoft Azure, is a good place to start. In an October note, Deutsche Bank forecast that GCP would break even next year with the help of a 68% increase in revenue to $7.9 billion, after posting a $703 million operating loss in 2019.
If one valued GCP at 10 times Deutsche's 2020 sales estimate -- it's worth noting Deutsche goes as far as to value it at 15 times a 2022 sales estimate of $16.6 billion, discounted back to the present -- it would be worth $79 billion. And if (as Deutsche forecasts) the business doesn't contribute to Google's earnings next year, little or none of this value would be accounted for when valuing Alphabet based on its near-term FCF.
There's also Google Maps to consider. It's the world's dominant online mapping platform outside of China, is a natural fit for local/mobile advertising and has only recently begun to be meaningfully monetized. Morgan Stanley sees Maps' revenue growing 64% next year to $4.86 billion, and reaching $11 billion in 2023.
And given Maps' various expenses, it might still be set to lose money or produce limited profits in the near-term. With the qualifier that estimating this is very much a guessing game, there's probably more than $50 billion worth of value in Maps that wouldn't be accounted for when valuing Alphabet based on its near-term profits or cash flows.
One could potentially add YouTube into the mix as well. The online video giant is now Google's second-biggest revenue growth driver after Google Search -- its annual revenue estimates are now generally above $15 billion -- and is most likely profitable at this point. However, this is also a business that Google has been making large infrastructure and content investments for, and thus valuing it at around 20 times its near-term earnings or cash flows would probably understate its actual value.
But for the sake of staying conservative, let's assume YouTube value is fully reflected in near-term Google FCF estimates, while deducting $79 billion from Alphabet's enterprise value for GCP, $50 billion for Maps and $65 billion for the Other Bets businesses.
That would probably leave the rest of Google -- including Search, YouTube, Google Play, the display ad business and the hardware businesses -- valued at less than 15 times its expected 2020 FCF. And with more aggressive valuation estimates for businesses such as Waymo, GCP and Maps, along with some attempt to grant additional value to YouTube, the forward FCF multiple might be more like 13.
To be fair, it's common for conglomerates to be valued at some kind of discount to what all of their businesses would be worth piecemeal. And as Stratechery's Ben Thompson recently suggested, concerns about Alphabet's corporate governance -- specifically, its unwillingness to break out the performance of major businesses, and its willingness to accept billions in losses for Other Bets one year after another -- might also be hurting its valuation.
Nonetheless, considering how dominant so many of Google's biggest platforms are, how much revenue growth businesses such as Google Search and YouTube are still seeing and how much growth potential businesses such as Maps, GCP and Waymo have, the valuation discount that Alphabet is being given looks excessive when one breaks out a calculator and starts looking at how much different parts of its empire are worth.