Google is one of the world’s most successful tech companies.
It was founded in 1998, coming out of nowhere to become the most popular search engine on the internet, beating established rivals such as Yahoo and Excite.
It’s one of those rare companies whose name has become a verb – you probably ‘Google’ something virtually every day.
This popularity has enabled it to make tens of billions of dollars by selling advertising. It’s a very successful business indeed, with a market capitalisation of around $450bn.
So why has it decided to change its name to Alphabet?
Google’s search engine is no longer its main focus
OK, it’s a stretch to say that Google is changing its name. Instead, the Google search engine unit will become a subsidiary of a new company called Alphabet.
What’s the big idea here?
For now, the web search business is still growing at an enviable rate. But with around half of the world’s population now online, the room for growth is becoming ever more limited. And there’s always the threat from competitors.
So what should Google do with all that money it generates from search advertising? It could simply return it to shareholders. But tech companies don’t like to do that – it’s a sign they’ve run out of ideas.
So Google has been spending a lot of money on new ventures, mostly through its ‘Google X’ subsidiary. Google’s goal is to transform other parts of our lives in the same way that the original product transformed internet search.
For example, there are its attempts to build mass-market self-driving cars (which seem to be going very nicely). There’s also a life sciences division that has released several products, including glucose monitors for diabetics. There’s even a unit that has long-term designs on “curing death”.
These are all very exciting, not to mention ambitious. But as Google’s projects get further from its core business, investors have started to get nervous.
Firstly, not all of these projects are successful, or even likely to be. While Google Glass (the effort to develop ‘smart’ glasses) isn’t completely dead, it failed to live up to its massive hype. And even the Google Car project faces strong competition from mainstream car companies.
Secondly, investors worry that running these ventures as a branch of Google makes it hard to measure how each part of the business is performing – which is vital for ensuring that the group isn’t just wasting money.
So essentially, Google is restructuring to provide some clarity, and is creating a holding company – Alphabet. This will have seven subsidiaries: Calico (longevity), Fiber (high-speed internet), Google (the core web business), Google Venture (the venture capital fund), Google Capital (another investment fund), Google X (moonshot projects), Life Sciences, and Nest (smart devices).
Founders Larry Page and Sergei Brin will run the overall company, while the core Google business will be left to Sundar Pichai.
This might look like a cosmetic shift. But from an investor’s point of view, there are a couple of significant points to take away here.
The founders no longer have day-to-day control over the web search division – Google’s core money-spinner. That suggests strongly that they believe this element of the group is close to reaching its full potential. It will still be very profitable, sure – but growth will continue to slow.
In contrast, the longevity, life sciences and emergent technologies parts will move from being an “interesting sideline” to being a major part of the company. In other words, ‘Google’ as we knew it, is very firmly no longer ‘just’ a search engine.
Some lessons from past reinventions in the tech sector
There are two key precedents for tech firm reinventing themselves: Apple and IBM.
Until the mid-1980s, IBM enjoyed huge growth thanks to its mainframe business and its lead in branded PCs. However, the mainframe market declined as firms no longer needed room-sized computers to store records. At the same time, the rise of cheap PC clones saw IBM’s market share collapse.
It took until the mid-90s for IBM to reinvent itself as a consulting and general computer technology firm. As a result, its share price moved sideways between 1983 and 1997, and it has underperformed the market overall.
By contrast, Apple managed to go from a near-bankrupt maker of niche PCs, to being one of the largest firms in the world, by taking bold bets on online music and smartphones.
What will Google turn out to be?
So which will Google (Nasdaq: GOOG) be? Its core business is far from being in decline, which demonstrates that the company is proactively looking to the future. Its valuation at 20 times 2016 earnings isn’t unreasonable, given the huge amount of free cash flow that it generates.
So if you hold Google, I’d stick with it. And if you’re in the market for a venture capital fund with its fingers in most – if not all – of Silicon Valley’s most interesting pies, then Google looks a good bet too.