Alphabet, the holding company of tech giant Google, remains “materially undervalued” despite the US Department of Justice’s (DOJ) ongoing antitrust case against the company, says Morningstar Equity Research analyst Malik Ahmed Khan.
The DOJ submitted its proposal on Nov 20 calling for Google to divest its Chrome browser, along with reduced self-preferencing, the removal of search agreements and greater data-sharing with rivals.
“We believe that the DOJ’s proposals, if implemented as they are, would have a material impact on Alphabet’s cash engine, Google Search,” says Khan in a Nov 22 note.
However, Khan thinks the DOJ’s proposal contains a set of remedies that are “unlikely to be implemented”. “We believe that even if the ruling by Justice Mehta includes some of these remedies, they are unlikely to be held up in an appeals court. From a timeline perspective, we expect the ruling on the antitrust case to come in mid-2025, with Alphabet appealing the decision soon after. The appeals court could take another year or so to release a final judgment, one which we think will be materially different than the DOJ proposal.”
Hence, Khan is maintaining his US$220 ($295.45) fair value estimate for “wide-moat” Alphabet, with a four-star rating against Morningstar’s five-tier scale. “[We] continue to view the name as materially undervalued. While we understand investor caution around the headline risk associated with the name, we believe it is attractively priced for long-term investors.”
Nasdaq-listed Alphabet’s shares fell 5% on Nov 21 after the DOJ’s proposal. “We believe investors are also overestimating how much of the DOJ proposal will feature in remedies imposed on Alphabet after the appeals court decision, which will come in 2026 at the earliest,” says Khan.
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‘Highly unlikely’
Khan believes parts of the DOJ proposal are “highly unlikely to be implemented”. Even if Alphabet is forced to sell the internet browser Chrome, Khan says there is no “obvious purchaser”.
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“Companies like Meta, Amazon and OpenAI would love to buy a scaled-up, highly-successful browser like Chrome. At the same time, there is a strong argument to be made that the results of any such buy-out would be equally anti-competitive,” says Khan.
Like Mozilla Firefox, Chrome could also be spun off as a standalone company, adds the analyst. “However, the issue with a spin-off is that more than 75% of Firefox's operating budget comes from its revenue share agreement with Alphabet. As an independent third-party browser, Chrome would likely be in a similar position, completely leveraged to search revenue sharing from larger search engines like Bing.”
Alphabet will not be able to have a revenue share agreement with an independent Chrome, notes Khan. This will likely materially affect its cash generation and ability to invest in areas such as product development and security.
Data-sharing
As part of its proposal, the DOJ wants Alphabet to share search query data with rivals and potential rivals by allowing them access to its search index at a marginal cost.
Along with the search index, Alphabet would have to provide the user and the advertiser data to its competitors for 10 years.
In the current search market, only two search engines crawl the web: Google Search and Microsoft Bing. New start-ups have stayed away from this space as building a viable search engine that can compete with Google is a “multi-billion-dollar expense”, says Khan, with revenue on the backend of this investment “far from guaranteed”.
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“By forcing Google to make data from its search indexes, feeds and models available to a tech behemoth such as Microsoft, we believe the DOJ risks illegally picking winners and losers in the search market,” he adds.
Migrating revenue share deals
Similarly, the DOJ’s proposal would “essentially prohibit” Alphabet from pursuing revenue share agreements while not explicitly preventing other search engines from setting them up, says Khan. “If this proposal is implemented, large companies like Apple and Samsung, which have historically benefited from the search exclusivity agreements, would simply migrate to a revenue share agreement with Bing, the only other at-scale internet browser.”
While Khan acknowledges that there is a “solid antitrust argument to be made” about limiting the exclusivity of Alphabet’s search agreements, he thinks prohibiting revenue-sharing only for Google Search “appears excessive” and is “unlikely to be included in the final judgment”.
“We find the prohibition of the revenue share agreements entirely odd, given Justice Mehta's Aug 5 judgment, in which he took issue with exclusivity clauses and not their nature as revenue-sharing agreements,” he adds.
‘Overly punitive’
On properties and devices owned by Alphabet, the DOJ proposed that consumers be provided a choice screen, where they can pick Google among other search engines.
To promote customer choice and education about alternative search engines, the DOJ proposal includes Alphabet funding a programme that would potentially provide individuals incentive payments to pick a non-Google default on a choice screen.
“Again, forcing a company to pay users to use its competitors’ products will likely be dismissed on appeal as overly punitive, especially when the primary competitor in the space is another multi-trillion-dollar company, Microsoft,” says Khan.
Finally, Alphabet's investments in artificial intelligence (AI) companies, such as Anthropic, could also face further scrutiny. The DOJ proposal would forbid Alphabet from having any investment in a query-based AI product.
“Again, we think that such a restriction, when only placed on Alphabet while its big tech peers are free to invest in artificial intelligence companies, is odd,” says Khan.
Shares in Alphabet closed at $166.57 on Nov 22.
