Sunday, November 6, 2016

Google, Facebook And a Deep Dive Into The Future of the Future (GOOG; FB)

From Institutional Investor's Banking and Capital Markets, Oct. 17, 2016;

Facebook and Google Wage War on Advertising

The social media and search engine giants have come to dominate the world of Internet advertising — taking over our lives and turning the traditional ad industry upside down in the process.
Page 1 of 4
An early morning in Greenwich Village sparks an epiphany about the growing chasm between the old and new worlds of advertising. My television displays the outdated stationary, scattershot approach to selling products: The talk show I’m watching is interrupted by a commercial for feminine incontinence pads. Wow, did they ever get my profile wrong!

Minutes later, out on the street, I step into the new era of mobile digital advertising. When I search my smartphone for running shoes on sale, Google instantly locates me and suggests a nearby Skechers store. But Facebook waylays me. As I pass a Starbucks, a hard-to-resist two-for-one promotion for lattes pops up alongside the news feed on my phone screen.

Over the past decade the traditional advertising market has been shattered by a high-tech earthquake. Internet advertising — dominated by Facebook and Google — has devastated print publication revenue and is now devouring the main income source of the TV broadcasting and cable industry. By the end of next year, digital ad spending will probably exceed TV revenue from commercials.

The two Internet giants use different strategies to capture ad revenue: Google depends on its search engine, whereas Facebook uses its vast social network. Eventually, marketers may be forced to decide which strategy best suits their products. But the advertising market is so large that the two companies have thus far avoided confrontations. “I don’t think they are headed for a showdown,” says Paul Greene, portfolio manager of the T. Rowe Price Media & Telecommunications Fund, which holds both Facebook and Alphabet, Google’s parent, among its $3.6 billion in assets. “There are still enormous pockets of revenue out there for Google and Facebook without attacking each other.”

Google, headquartered in Mountain View, California, makes headlines with its projects for driverless cars, cloud computing and smart-home devices. Facebook, just ten miles away in Menlo Park, has become the mightiest source in the news industry. But above all, the two Silicon Valley giants are advertising platforms — the most effective and pervasive the world has ever known. Ads provide more than 90 percent of their revenue and profits.

Google enjoys a near-monopoly of online searches. As its chief executive officer, Sundar Pichai, tirelessly proclaims, “Google’s mission is to organize the world’s information and make it universally accessible and useful.” Facebook has a stranglehold on social networking. Its mantra, cited at every company presentation by co-founder and CEO Mark Zuckerberg, is “to give everyone in the world the power to share anything with anyone.”

Investors wax enthusiastic over both approaches to advertising. Google is unbeatable for consumers who have already decided to purchase a product and are searching for a favored brand at the cheapest price. “Per unit of time spent, search monetizes dramatically better than any other form of advertising, and it always will,” says Gavin Baker, who manages the Fidelity OTC Portfolio, whose $13.3 billion in assets include Alphabet and Facebook.

But there is a whole advertising market that search cannot address: the ability to offer products to consumers based on the interests and preferences they have shared in their Internet communications with friends and family. And Facebook, which pioneered social networking, is virtually unchallenged in this market. “Advertisers increasingly view Facebook as a platform where you can reach very large audiences and target people down to the micro, individual level,” says Eric Sheridan, a New York –based media analyst for UBS Securities.

For now, Google parent Alphabet is the much larger company, with a market cap that is almost 50 percent higher than Facebook’s and revenue last year that was four times greater than its rival’s. But Facebook’s earnings grew more than three times faster than Google’s in the first half of 2016. And Facebook keeps users glued to its apps twice as long as Google does. More “eyeball” time eventually translates into higher ad revenue.

Google is obviously concerned by its competitor’s rapid gains. A spokesman said it was company policy not to make Google executives available for a story that would include interviews with Facebook executives. By contrast, Facebook offered interviews without preconditions with two of its leading advertising managers: Will Platt-Higgins, vice president for global client partnerships, and Patrick Harris, global director of agency development.

Both Alphabet and Facebook bask in Wall Street’s admiration. They are rated buys and strong buys by an overwhelming consensus of equity analysts; not a single analyst has a sell or underperform rating on either one. Both companies have gross profit margins that are almost without historical precedent: 62.4 percent for Alphabet’s Google and 84 percent for Facebook last year.

Margins like these are obliterating any remaining trace of the Mad Men era of advertising. The slow, costly face-to-face pitches to clients by Don Draper have given way to cheaper, faster computer-generated ads on five-inch iPhone and Samsung Galaxy screens. An oft-repeated maxim on Madison Avenue is that agencies must deliver the right ad to the right person at the right time. “But increasingly, the right person at the right time of that equation is being handled by machines,” says Ian Schafer, chairman of Deep Focus, a New York–based ad agency. “And while machines may not yet be responsible for creating the right ad, it also gets chosen by machines.”

No companies have smarter machines — armed with the latest artificial intelligence — than Google and Facebook. After claiming two thirds of the $59 billion in U.S. online advertising revenue last year, the pair stand to increase their market shares in 2016 thanks to their mastery of the two foremost media trends: the shift from desktop computers to mobile phones and the increasing use of video rather than words in advertisements.

“The most intimate device in our lives is the smartphone,” says Rich Greenfield, a New York–based media analyst at global brokerage BTIG. “So the whole media world is trying to go mobile.” Facebook is the leader. Only four years ago desktop computers accounted for almost all ad revenue at Facebook; today 84 percent of this income is generated on smartphones. At Google mobile ads account for slightly more than half of revenue.

But Google is far ahead of Facebook in video because of the explosive growth of YouTube, which Google bought ten years ago for $1.65 billion. In the coveted 18- to 34-year-old market, YouTube reigns supreme, even over broadcast and cable television. “While TV networks are losing audiences, we are growing in every region and across every screen,” YouTube CEO Susan Wojcicki boasted to an audience of some 20,000 ad executives at VidCon, an annual online-video conference held in Anaheim, California, in June. “Today more Millennials tune into YouTube on mobile alone during prime time than to cable or broadcast TV networks.” According to investors, the future looks ever brighter.

“If anything, everybody is underestimating YouTube’s potential,” says T. Rowe Price’s Greene.
Even before Google and Facebook fully exploit their video potential, both companies are hard at work on competing devices for augmented and virtual reality. Zuckerberg believes VR can someday supplant the smartphone as the main connection to the Internet and as a platform for advertising. The headset by Oculus, a company Facebook purchased two years ago for $2 billion, is considered the most advanced VR device on the market. “Clearly, Facebook is further along in virtual reality thanks to Oculus,” says Ben Schachter, a New York–based media analyst for Macquarie Capital. “But Google is making a lot of investments.”

Given the extraordinary speed of Internet developments, there is no assurance that Google and Facebook can stave off future threats., for example, could leverage its e-commerce might into advertising. Snapchat, a five-year-old messaging and photo-sharing service with enormous appeal among younger people, is growing at a Facebook-like pace.

But for now the most serious problems facing Google and Facebook are linked to the fear their mammoth size provokes around the globe. In Europe, Google stands accused of abusing its dominant position to ward off smaller rivals and as a result is battling several suits that could cost it billions of dollars. In the U.S., Facebook has aroused suspicions among conservatives that its news coverage is slanted toward liberals. Meanwhile, news publications of every political stripe are becoming beholden to Facebook as a vehicle for wider exposure of their content and a source of ad revenue.
Some investors are wary of the new shareholding class created by Google’s and Facebook’s founders to ensure they will continue to guide their companies without pressure from Wall Street (see “Facebook and Google Embrace Innovation, Not Corporate Governance,”). “Some founders seem to feel that just because shareholders supply capital doesn’t mean they should enjoy corresponding rights,” says Brian Wieser, a senior analyst at New York–based Pivotal Research Group, an equity research firm.

Such hubris is understandable when geniuses in their 20s build enterprises that within a few years soar to the pinnacle of the business world. Sergey Brin, a Russian immigrant, and Larry Page were Ph.D. students in computer science at Stanford University when they created a search engine as a research project in 1996. A year later they registered it as a web domain,, and in 1998 they formally incorporated it as Google. By then it was already vaulting past more-established search engines, like Yahoo! and Lycos.

In 2000, Google began to display text-based ads on its web pages. The business accelerated so rapidly that in 2001, on the advice of investors, Brin and Page hired Eric Schmidt, a seasoned software executive who had headed Novell for four years, as Google’s first CEO. Three years later came an IPO, which valued Google at more than $23 billion. Today Brin and Page, both only 43, are worth more than $37 billion apiece. Schmidt, 61, is now executive chairman of Alphabet, with an $11.3 billion fortune of his own.

Facebook’s ascent has been even more spectacular. The hit 2010 film The Social Network chronicled Zuckerberg’s sharp-elbowed sprint to create Facebook with several college classmates in 2004 before dropping out of Harvard University and moving to Silicon Valley. A key step in managing Facebook’s fast growth was the hiring of Sheryl Sandberg as chief operating officer in 2008. She had spent the previous seven years at Google, in charge of global online ad sales. Numerous other talented Google alumni also flocked to Facebook, which gained a reputation as the Internet’s hottest company.
In the four years after its 2012 IPO, Facebook reached a $300 billion market cap faster than any business in history. And today Zuckerberg, 32, is the sixth-richest human on the planet, with a personal worth of more than $55 billion....