The ABCs of Alphabet's Legal Woes

10/27/2020 5:00 am EST

Focus: TECHNOLOGY

Richard Moroney

Editor, Dow Theory Forecasts

The U.S. Justice Department has sued Alphabet (GOOGL) on antitrust grounds, notes growth and income expert Richard Moroney; here, the editor of Dow Theory Forecasts offers his case for continuing to recommend the shares.

This suit was a well-telegraphed move that accuses the company of unfairly protecting its Google search and advertising businesses that dominate their respective markets.

The lawsuit focuses on Alphabet using advertising revenue to pay smartphone makers like Apple (AAPL) to make Google the preset search engine on devices, creating a cycle that drives yet more ad revenue to Alphabet. Several states might file a separate antitrust lawsuit against Alphabet in the coming weeks.

Alphabet has built a massive and sprawling online presence. It controls an estimated 92% global share of online searches and a 40% chunk of digital ads, according to The Wall Street Journal.

About 75% of global smartphones run on Alphabet’s Android operating system. YouTube accounts for about 73% of online video, while Google Maps has a 70% market share and Google Chrome has a 66% share of all web-browser usage.

On its face, the lawsuit resembles a similar antitrust stance the U.S. took against Microsoft (MSFT) in 1998. In that case, Microsoft accumulated a huge presence on personal computers, partly by paying PC makers to preinstall its Internet Explorer browser.

Microsoft ultimately lost the case and was forced to change its tactics. If the U.S. ultimately prevails in this case, it’s not clear whether Alphabet may be forced to alter its practices, pay a fine, or divest some of its businesses. But any resolution is likely years away, and Alphabet shares have risen since the lawsuit’s announcement.

Meanwhile, we see room for the shares to run higher as Alphabet benefits from favorable online trends that are only accelerating with the coronavirus pandemic. Retailers use Alphabet’s cloud services to host websites, store data, and process orders, essentially forming the backbone of their e-commerce operations.

Alphabet trades at 35 times estimated 2021 earnings, a 7% discount to its industry median. Excluding net cash of $153 per share, Alphabet has a trailing P/E of 30 and estimated 2021 P/E of 32. Alphabet remains a "Long- Term Buy".

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