Waymo Coming?


Alphabet’s earnings press release didn’t talk about it. Alphabet CFO, Ms. Porat, did say that revenues increased 22% from the prior quarter, making it a “terrific start to 2017”. You’ll need to wait until Alphabet releases its next quarterly 10-Q to find out about the Waymo v. Uber lawsuit.

Filed in February 2017, Waymo v. Uber avoided disclosure in Alphabet’s last filing for the quarter ended December 31, 2016. What’s known about the case has come mostly from court filings, but we have not heard much official from Alphabet. That should end when Alphabet files its 10-Q for first quarter of 2017.

Legal proceeding can be boring, but when money is at stake, then the bottom line can be impacted. Alphabet recently escaped paying billions in damages to Oracle in another lawsuit over intellectual property. Waymo v. Uber should prove that tech companies not only fight in the marketplace, but also in the courtroom.

Alphabet’s 4Q16 Earnings

A one-time tax benefit ruined Alphabet’s recent quarterly earnings release. Alphabet’s earnings for the fourth quarter of 2016 were lower than analysts estimates when compared with the prior year.

Contributing to the less than expected earnings was a higher tax expense of $1,524 billion as compared with $277 million from the prior year.  On the conference call, CFO Ruth Porat described the tax hike this way:

And then, the other item I noted was, with respect to our tax rate. I noted that there was a slightly elevated tax rate this quarter. It’s always affected by the geographic mix of results, but we did have a discrete item that affected the US tax rate, just to make that clear.

Some attributed the “discrete item” to a one time adjustment for stock based compensation. But this is not the case. In fact, the “discrete item” was from the prior year as stated in Alphabet’s SEC Filings:

Our effective tax rate for 2015 included a discrete tax benefit related to refunds and reductions in uncertain tax positions due to the resolution of a multi-year tax audit in the U.S.

At the end of 2015, Alphabet revised its estimated tax expense as a result of an IRS audit that covered many years. The IRS ruled in Alphabet’s favor causing the tax expense to be less than expected. The adjustment occurred in the 4th quarter of 2015 and made the 4th quarter of 2016 higher in comparison.

Income tax expense is not really the amount of taxes paid; instead it is an estimate. At the conclusion of its IRS audit, Alphabet’s revision pushed the effective tax rate to five percent for the quarter. One year later, the quarterly effective tax rate when back to “normal” at around twenty-two percent.

All of this should prove that GAAP based financial statement are somewhat meaningless or at least can’t be taken at face value. In their recent book, authors, Baruch Lev and Feng Gu, argued that GAAP based financial statement include so many estimates, that true corporate earnings are often obscured.


Verily’s Expanding Pies

Singapore’s sovereign wealth fund, Temasek, purchased a slice of the Alphabet’s other bet, Verily. This is after Alphabet reportedly put more money into Verily. For its exchange of $800 million, Temasek becames a minority partner and values, at most, Verily, at $1.6 billion. The deal was made possible by Verily’s establishment as a limited liability company, rather than corporation, in August 2015.

In the past year, Verily was the one doing the investing. In August 2016, GSK and Verily form a joint partnership, called Galvani Bioelectronics, by each business contributing intellectual properties and cash over seven years. In this exchange,Verify owns forty-five percent of the joint venture and GSK holds the remainder. Verify, for its part, would be required to contribute $10 million each year as a minority partner.  

Then in September 2016, Verily formed a joint partnership with Sanofi that was valued at $500 million. Sanofi put in a reported $250 million and Verily contributed an unspecified amount. Before all of this, Verily and J & J formed the medical robotics company, Verb Surgical Inc., back in 2015. No financial details were released on the Verb Surgical Inc.

Verily could use Temasek’s $800 million to fund its future commitments to the already formed joint ventures. What does Temasek get in the exchange? Temasek will now gain as it helps Verily expand its pie in Asia and especially, China.

As the majority partner in Verily, Alphabet gives up some of its interest in exchange for reducing risk. It was reported that earlier this month, Alphabet invested in Verily, too; this time, the amount was $1 billion.

How Innovation Dies at Apple

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Steve Jobs passed away about five years ago and some question whether innovation passed away at Apple too. Due to its secrecy, it is hard gauging the developments inside Apple, unless you’re an employee or have a golden ticket. From the outside, should Apple’s innovation be measured by new products, new ideas, patents, or spending?

Apple and its competitors have increased spending on research and development since 2011. By looking at Chart I below, you can see that the direction is upward for Apple, Alphabet, Facebook, and Amazon. Apple has nearly quadrupled spending on research and development from $2.4 billion in 2011 to $8.5 billion in 2015.

R D Spending
Source: Annual Reports

So all is well? It difficult to determine the success or failure based solely on money spent. There is no direct connection between research and development spending and the bottom line. Ratios could be used such as research costs to total revenue.  But since there is no causality between the money spent and net income, financial ratios may not be the best measure.

Another way to judge Apple is by the number of patents granted. Chart II shows the number of utility patents granted to Apple and its competitors, per year, for 2011 to 2015. By showing the yearly change, rather than the overall total, one can see that Apple is reversing and Alphabet is speeding  ahead.

Patents Granted
Source: Intellectual Property Owners Association’s Annual Top 300 Organizations Granted U.S. Patents

In addition, you can see the emergence of Facebook during the same period. Since its IPO, Facebook has increased research and development spending from $1.4 billion to $4.8 billion. In the same period, Facebook was granted 127, 279, and 374 patents for 2013, 2014, and 2015 respectively.

Amazon is another surprise. Like Apple, Amazon is very private. Rather than not say anything, Amazon obscures its true actions. For example, Amazon does not report its annual research and development expenses. So the amount shown in Chart I above is somewhat misleading. And it could also be misleading to those outside of Amazon.

Amazon reports its research and development as technology and content. Technology includes primarily research and development expenses, but Content does not. Content includes all the costs associated with “category expansion, editorial content, buying, and merchandise selection.” Technology and Content went from $2.9 billion in 2011 to $12.5 billion in 2015.

Since Amazon buries its  research and development expenses, you really know nothing. You do know from patents granted, that something is happening at the on-line retailer. In 2011, Amazon was granted 180 patents and five years later, it was granted 1,136 patents. In terms of patents granted, Amazon has come from nowhere while Apple is slowing down.

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Alphabet Bets Really Big on Startups in 2016

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Alphabet invested an estimated $100 million in new ventures during the first quarter of 2016. That and other information about Alphabet’s corporate venture capital activities were disclosed in its recently filed Form 10-Q.

Blackout. Google Capital and GV funnel Alphabet’s cash into new ventures. The two units are part of Alphabet’s other bets. After the reorg last year, Alphabet has provided investors with more disclosure about the non-Google activities. But mostly, the other bets are lumped together as one line number on the financial, so the transparency is well, not so clear.

From the 10-Q, filed near the end of April, we know that Alphabet invested an average of $5 million on startups during the quarter. Based upon information from Crunchbase, Google Capital invested in three companies – Pindrop, Girnar, and Cardekho. GV was busier by investing in 16 companies (see table below).

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Red. Read more closely, the 10-Q tells even more about GV and Google Capital.  Total investments in private companies went from $2.6 billion to $2.7 billion, or an increase of $100 million for the quarter ended March 31, 2016. Alphabet is accounting for these investments under the cost method, which means it generally owns less than 20% of the company and/or does not exert any significant control.

Alphabet also values GV and Google Capital investments at $7.8 billion for the recent quarter. That value increased by $300 million from the beginning of 2016 when the fair market value was $7.5 billion. Alphabet estimates the fair market value using private market transactions, since public market transactions are not available.

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More Green. After some adjustments, Google Capital and GV holdings’ appreciated 3% during the quarter. Here is how. The fair value increased $300 million during the quarter, from $7.5 to $7.8 billion. The fair market value can increase due to additional investments and by appreciation.

So from the $300 million, we must subtract the known additional investments of $100 million. Thus we arrived at the assumed appreciation of $200 million or 3%.

But the $100 million is an really important amount, especially at this time. In the past five years, non-venture capital money has followed into Silicon Valley from hedge funds, sovereign wealth funds, family offices, and mutual funds. It seems these players are now pulling back.

So it may be good know that, money is still following into the sector.

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Alphabet, Apple, Salt, and Pepper


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Financial ratio just compare different things; an example would be comparing salt and pepper or Kanye and Kim. Entrepreneurs and venture capitalists can use them (ratios) to manage their business. A SaaS business may need to consider its sales efficiency which compares marketing expenses and incremental revenue. The venture capitalist may need to know internal rates of return.

Don’t look there. Look here.  If you read online about financial ratios, you may find textbook explanations. But like sleight of hand, you to need to look another way not to be fooled. Financial ratios just compare two things. For example, a common measure of company profitability is return on equity (ROE). It can be expressed as net income divided by shareholder’s equity.

Another way to think of return on equity, is as a rate of return. For example, an interest rate can be expressed as a rate of return. Assume you deposit $100 into the bank. One year later, you get back $10. If you compare the $10 to the $100, the ratio is 10%. Said another way: you earned a 10% percent interest rate or your rate of return was 10%.

Return on Equity. ROE can also measure how much you will earn if you put your money into a business rather than the bank. ROE compares net income and total shareholder equity.  How do we get shareholder’s equity? An investor gives money to company in exchange for stock. The cash received by the company represents the shareholders equity.

When you buy stock, it’s as if you deposit money into the company.  Now management takes your cash and tries to make more. Stock is more than just a piece of paper; instead it is fractional ownership interest in the company. In theory as an investor, you own a piece of the net income. The net income can be paid to you as a dividend or kept by the company to make money.

Comparing Apple and Alphabet.  For the year ended December 31, 2015, Apple’s return on equity was approximately 43% and Alphabet’s was 15%. So if you give $100 to Tim Cook, he will earn $40, while Larry Page will only return $15 to you. Does this mean Apple is better investment than Google? This post is not meant for investment purposes, but explain to financial ratios.

An investor have many places to put their cash: gold, apartments, land, or under the mattress. Earning the most is the prize. So would rather put you money in a company with ROE of 20% or in the bank with an interest rate of less than zero. The choice is yours, but thinking in terms of rate of returns can be helpful.

SaaSy. Think about sales efficiency in terms of comparing two different things. Here you are comparing marketing and incremental revenue.  If you put $500,000 into marketing and sales and the incremental revenue is $1 million, then sales efficiency is a multiple of two.

For every time you put $1 dollar into marketing you earn $2 dollars of revenue. Is that good or bad? Well like the ROE example, you need to compare it to something else like the sales efficiency of industry. Then you can decide how well you are spending your marketing dollars.

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