Global Equity Spotlight Episode 17

Hello everyone, and welcome back to Global Equity Spotlight, a series where we delve into interesting topics affecting equity markets. Today I have Jacques and Cornelius joining me. Thank you guys for being here today. So maybe we can kick off with trying to understand where markets have been in the past few months. They’ve been quite inefficient — we’ve seen the likes of Alphabet and Microsoft reacting very differently over the last few months and years. Maybe you could help us by first unpacking how complex the Alphabet business model is.

Yes, I suppose you can see the market as inefficient, or too efficient, because the market has shifted its rating on these companies very dramatically as the narrative has changed around the investment cases. Last year, everyone was pricing Alphabet as if the search business was dead. Search is the main profit driver of Alphabet — it generates roughly the same revenue as Meta from search, and we saw in the latest quarter they’re growing mid-teens in that business, so it’s still a very powerful business for them. Then you have the YouTube business, which is the same size and growing very strongly — same size as Netflix. And then, of course, these days you have a high-growth cloud business. This business is now contributing roughly 20% of operating profit, which has basically doubled over the last year because we saw in the latest quarter revenue growth accelerating up to 80%. So already here you have three highly profitable businesses, and then they have a lot of other bets — a big investment in SpaceX, in Anthropic, they have Waymo — and these investments don’t really contribute to revenue or profits. The businesses are actually loss-making, but it doesn’t really come through in the numbers for Alphabet, because they actually posted very big fair value gains on these investments, and collectively this investment portfolio is worth more than $300 billion.

If we look at the cloud business relative to peers, you can see they’re outgrowing Amazon AWS and Microsoft Azure. But all three cloud businesses have accelerated revenue over the last six quarters, and you’re seeing the two bigger companies growing close to 40%, and Google’s now actually growing at double that rate. So it’s a very complicated business, but it’s definitely not just dependent on the legacy search business, which everyone focused on last year.

And maybe pivoting off that — Jacques, maybe you can help us unpack the narrative shifts that we’ve seen in these underlying companies.

Yeah, sure. So the narrative has shifted quite a bit. Microsoft used to trade somewhere between a 40% to 60% premium to Google for the last few years. Up until last year, Microsoft was seen as having a first-mover advantage with their relationship and investment in OpenAI, and they actually traded up to a 100% premium to Google in the middle of last year. Then, around OpenAI, the market started to question it — Anthropic’s revenue overtook OpenAI’s revenue. Microsoft had questions around their capex spend, there were questions around Copilot lagging some of the other LLM models, and, of course, Microsoft is also in the software space, so they sold off quite aggressively with the software sell-off, to the point where Google actually traded at a 20% premium to Microsoft. At that stage, Google was seen as one of the leaders within the AI space, with their full stack from chips to applications to their cloud business.

And then within this year we saw quite a big pivot again, because Microsoft went from a 20% discount to Google to now trading actually at a 20% premium to Google — quite a dramatic shift in the narrative, because they’re now one of the only hyperscalers showing positive free cash flow. So these are very big companies, with almost 100 sell-side analysts covering them, and the whole world has their eyes on the business, and you would think these companies wouldn’t trade as volatile as they do. But clearly we’ve seen massive opportunities to shift portfolio positioning between the two names, as you see these big dislocations in ratings as the narrative has shifted.

Brilliant. Thank you so much for unpacking these underlying narratives and the complex environment that we are operating in today. To the audience, thank you so much for joining, and we’ll see you next time.