Why Alphabet Inc Needs to Act Fast to Reassure Advertisers

In this podcast, the Market Foolery team turns its attention to the latest controversy at YouTube as major advertisers have complained about their ads appearing next to objectionable videos. As the online advertising race between Alphabet (GOOGL 0.57%) (GOOG 0.62%) and Facebook (META 3.53%) intensifies, the internet giant has no choice but to address the issue quickly.

To wrap up the show, the team also answers a listener question for Canadian investors before discussing the state of March Madness.

A full transcript follows the video.

This video was recorded on March 27, 2017.

Chris Hill: It's Monday, March 27th. Welcome to Market Foolery. I'm Chris Hill. Joining me in studio today, from Million Dollar Portfolio, Jason Moser; and from Stock Advisor Canada, Taylor Muckerman. Happy Monday!

Jason Moser: Hey, now!

Taylor Muckerman: We're doing it!

Hill: We are doing it. Welcome back! You've been busy.

Muckerman: Yeah, a couple weeks. You were at South by Southwest. We've been overlapping each other.

Hill: There we go. It's good to have you back in the studio.

Muckerman: It's good to be back.

Hill: We're going to dip into the Fool mailbag. We have to start with a story that's been brewing for a little while. I'll be honest. This is a story, I saw a headline on this a week or two ago, and it registered like, huh, that's interesting, and it continues to balloon. This is the fact that a week ago, Google formally apologized for running customer's ads alongside objectionable videos. We've talked before about YouTube and how important it is in the world of search, and how it's one of the most popular places to search. And you see these stories about, if YouTube was a stand-alone company, it'd be worth somewhere in the neighborhood of $75 billion. Google makes this apology a week ago, and here we are a week later, and I guess, among other things, Jason, probably a reminder that YouTube is a really big place with lots of videos, and therefore it's hard even for the owners to monitor it. The Wall Street Journal had this big story about how Coca-Cola, Microsoft, Amazon, Procter & Gamble, these mainstream brands, are still seeing their ads alongside videos with racist content, anti-Semitic, all of this stuff where the advertisers, rightfully so, say, "I don't want my ads next to that."

Moser: Yeah. We're going to hit a point here, sooner or later, it's going to be like you do with your kids, they can say sorry only so many times before you're like, "I get that you're sorry. Just don't do it again. I'm not looking for sorry anymore." So, I think with Google and YouTube, this is obviously something that's a big deal. It's not something that immediately impacts their bottom line. When we talk about the bread and butter for Google's money-making machine, it's search advertising. But, there's a good percentage, close to 20% of that money, comes through advertising with third-party customers. So, when ads go next to objectionable content, of course, those parties are going to express concern, they want to know what's going on, why is this happening, and what are you going to do to make it stop? Because there is no middle ground here. It's just, flat-out, "This is unacceptable, don't let it happen anymore." This is sort of one of those things with this age of automation, as we go more toward automating everything, particularly on the consumer-facing side, I think it's really difficult to ever fall back on the old, "Well, the algorithm did it, it wasn't our fault." Because, ultimately, someone built the algorithm. 

I think what Google needs to figure out here is, what is happening to make this happen, and how do they fix it? And whether it is through technology, whether it's through humanizing it a little bit more, and actually bringing on more people to add a human touch to these customer relationships, they need to do something with this before this gets out of hand.

We've talked about this a lot, especially in MDP, we own shares of Alphabet, and we own shares of Facebook: We own a far larger position in Facebook, and part of the reason for that is, when you look at the direction things are headed in social, and in internet behavior, there's no question that Facebook is becoming a place, not just Facebook, but its properties, whether it's WhatsApp or Instagram or whatever properties they buy in the future, that's a place where eyeballs go to hang out for a while. Google is more utilitarian in nature, right? You need some information, you find it on Google, and you go to your next place. Facebook is catching up very quickly. They've expressed some concerns that perhaps the last decade was the Google decade, and perhaps this next decade is the Facebook decade. If that is the case, and the numbers certainly point toward that, the argument could at least be made there, Google has got to figure out something yesterday as to how to address this and fix it, because blaming it on the technology is not going to fly.

Muckerman: I'm pretty confident that they're going to figure out a way to fix it. Especially when you're talking about Facebook, they had the whole issue around the election with fake news on their site. And you had a group of college kids come out and make an algorithm that was able to identify fake news on the site, and they've been able -- not using their algorithm, but, Facebook has been able to address that. I'm confident that Google will. You talk about big headlines about this, but I'm waiting for the headline to come out that says, right now, people think that less than 1% of Google's revenue is at risk because of this. It's a $90 billion revenue company, I've seen headlines that say $750 million might come off of YouTube's revenue in 2017 because of this. Bigger fraction of YouTube's revenue, but you're not just an investor in YouTube when you buy a stock in Alphabet. So, I'm still confident that they'll figure it out. And between the two of them, Facebook and Google, they're pretty much the only two that are growing in the digital ad space. So, I find it hard to believe that advertisers are going to completely move away from Google. Right now, Facebook is really the only alternative, and that space would become far too crowded too quickly if there was a mass exodus from Google. I'm fairly confident that, because you said 20% of their revenue comes from that search advertising, they're going to figure this out.

Hill: It is a small amount of money, and yet, when you look at the headline of Pepsi, Starbucks, General Motors, Wal-Mart have pulled some of their ad spend with YouTube. Those are big-name companies. I think, if you're Facebook, you're not throwing a parade over this, but I think if you're selling video advertising for Facebook, you're on the phone to different media agencies, and I also think television networks. If you're a broadcast network or cable network, to use your phrase, Jason, you're putting the human touch to work, and you're calling these companies and saying, "Listen, don't take a risk with the programmatic algorithm approach to YouTube. You know what you're going to get with our networks, and you're going to get something that associates well with your brand."

Muckerman: With some of those companies you mentioned, those are companies that can afford to pull back for a week or two on advertising and make a statement. That's almost advertising in itself. They're still advertising using Google's name, just not using Google's platform. So, I think they'll come back eventually. Probably not too far down the line. Those brands are brands already. You're probably looking at the smaller players, questioning whether or not they can afford to back off of Google's platform a little bit more than Coke or Pepsi.

Moser: Yeah, and I think it's also worth noting, for the longest time, YouTube has been synonymous with online video. That's what got this ball rolling. And they've enjoyed such a phenomenal competitive position for so long. What an acquisition Google made for ... what did they buy it for?

Hill: $1.6 billion.

Muckerman: Pennies on the current dollar.

Hill: And the reason I remember it was $1.6 billion is because I was one of the people saying, "Boy, they sure did pay a lot of money for that."

Moser: So, I think you fast forward today and you see how this competitive environment has changed, Google and YouTube are not the only players in the online video space. And you see all sorts of companies, from Facebook and Twitter to Verizon and AT&T developing their online video offerings. To your point, I think it's very easy to see these customers pulling back for a week, a month, and saying, "Hey, let's reasses what's going on here." Google and YouTube are too big to say, "We don't want to be a part of your environment." That's just foregoing a tremendous reach that anybody in their right mind would want to be a part of. But, what it could do is, it could result in some pricing competition. It can certainly make Google have to get in there and compete a bit more on pricing, lose a bit, perhaps, of that pricing power, particularly as we ship to mobile, and we know those mobile advertisements are not nearly as lucrative as the desktops were, from a real estate perspective. But, these are smart people running a very, very big company. The solution to this really is as simple as, listen to your customers and give them what they want. So, from that perspective, I don't see any reason why they can't fix it. I guess it's going to be interesting to see how they fix it, and how quickly they go about fixing it, because they don't enjoy that same competitive position that they enjoyed, perhaps, five years ago.

Hill: Our email address is [email protected]. From Matt Saunders in Nestleton, Ontario. "I was hoping you could explain the effects of currency exchange on stock purchases. I'm in Canada and our dollar is quite low compared to the U.S. dollar. However, it wasn't too many years ago, we peaked a little higher than the U.S. dollar. My concern is that if I buy a U.S. company at this point and the dollar rises again, will that work against the value of the U.S. company that I purchased? Or does buying on the TSX compensate for that somehow? Thanks for all your help with this. P.S. please tell Steve Broido, we just made a trip to Orlando and had a great visit to an Olive Garden there. Definitely a fan." Steve will appreciate that, I'm sure.

Muckerman: Yeah. Thanks for listening all the way from Ontario. This was a question that we receive quite often in Stock Advisor Canada, Pro Canada, and now Dividend Investor Canada. We put a special report about this a couple years back. Over those couple years, not much has changed. Remain to see the Canadian dollar still trading below the U.S. dollar. I think right now, it's around $0.75 to the U.S. dollar. As you did mention earlier in the 2000s, the Canadian dollar did peak around $1.20 to the U.S. dollar. That ramp-up really did cramp Canadian investors' returns when you look at it, from investing in the U.S. dollar. When the Canadian dollar does appreciate, you lose a little bit there when you sell back into the Canadian market. So, what we generally tell our members to do is, A) we absolutely recommend investing in the U.S. market, because when you look at the Canadian market, about two-thirds of it relies on the energy, financials, and the materials sector, two very volatile sectors, in the energy and materials sector and then financials, really, the bulk of that is driven by the big banks, TD, Scotia, CIBC, BMO, and RBC. They're very highly concentrated if you don't move outside of the Canadian market. When you look at the largest sector in the U.S., IT, I think that's around almost 22% of the S&P, it's 2.7% of the S&P TSX. So, you're missing out on a lot of potential growth there. And less than 1% of the S&P TSX is healthcare. If you think about that, you're missing out on some huge potential growth there. It was a little higher, but Valeant obviously reduced the share of that overall market when that fell precipitously over the last couple years. 

But, the long-term average of the Canadian dollar to the U.S. dollar is right around $0.85. There's about 13% upside from where it is right now until it reaches the long-term average, I think we have information going back to 1971 on our site. That's over 30 to 40 years of data with the long-term average of $0.85 to the U.S. dollar. So, you're not far away from that. Compared to that $1.20 you saw in the early 2000s, we view that as a one-off event, especially with oil where it is these days, and the likelihood that remains subdued as compared to when it was over $100, which, coincidentally, timed very well with when it was peaking with the U.S. dollar there. So, we advocate people considering the Canadian dollar to the U.S. dollar exchange rate, but we don't say, "Just invest Canadian only." Put some dollars into a separate account, leave them there for the long-term so you don't have to pay the cost to exchange back and forth, because banks do charge for that. And you don't get charged if the company pays you a U.S. dollar dividend and you leave it in U.S. dollars. You don't get charged every time they deposit the dividend to your account. You only get charged if you put it back into CAD. So, if you're a long-term investor, we just say, create two accounts, one with Canadian dollars and one with U.S. dollars, and let it ride, because if you don't, you're going to miss out on tons of opportunity. TSX and TSX Venture stocks make up about 20% of the --

Hill: Toronto Stock Exchange.

Muckerman: Yep. They make up about 20% of the total stocks available to you in U.S. markets. So, not only are you missing out on diversification, but you're missing out on opportunity, in terms of breadth of choices. So, don't let the currency fluctuations scare you away from it. That's our opinion.

Hill: You've been to the Toronto Stock Exchange, haven't you?

Muckerman: Yeah, it's pretty cool. We went there a few years ago, poked around when we were first launching Stock Advisor Canada in 2013. Been up there a couple times since, but to not the same fanfare that we went up there a few years back.

Hill: Definitely a lot of fun. Fitting that I'm sitting with too proud sons of the Carolinas because, for any sports fans out there, the final four is set. We have Gonzaga, we have the University of North Carolina, we have Oregon, and we have, surprisingly, the University of South Carolina. And the potential for an all-Carolina final.

Moser: Amazing. If you think about it this way, you had Clemson just win the National Championship in college football. There is still the potential, certainly, for the Gamecocks to go in there and win this thing in basketball. Which, I mean, there's no way that's ever been achieved before.

Muckerman: They have to win this, because the likelihood of a potential rematch with North Carolina in the final, highly unlikely. Although, this could boost recruiting.

Moser: About half of my graduating class in high school went to USC. The other half --

Hill: The other USC. Most people hear USC and they think University of Southern California.

Moser: The East Coast, South Carolina. The other half went the Clemson. And I was the one lone straggler that went the opposite direction and went to a 15-person liberal arts college. Go, Wofford Terriers.

Hill: Wait, isn't Wofford in North Carolina?

Moser: Wofford is in South Carolina. You have Davidson that's in North Carolina.

Muckerman: Steph Curry.

Moser: But, wow, the finish to that game yesterday was ...

Muckerman: The Carolina game? Yeah, my gosh.

Moser: Yeah, it was unbelievable. I have to believe that right now, the Carolinas are figuring out a way to, perhaps, join together, erase that border.

Hill: There was a story I read this morning -- and, obviously, there's so many millions of dollars involved in the NCAA basketball tournament. But one of the stories I read this morning was about the business impact in North and South Carolina. And, not surprisingly, bars and restaurants doing huge business over the weekend, and presumably will do it again next weekend.

Moser: That'd be like one of those things in an earnings report where, that's one of those one-time events. So, when you're saying, "Well, we don't expect this next March, but we had a very robust beginning of 2017, thanks to ... "

Hill: You're saying Jason's Barbecue and Sports Bar, in South Carolina, when it's reporting earnings in the spring of 2018, it's like, "Look, tough comp. Last year, we had the final four. We had Clemson in the football championship."

Muckerman: Seriously. Clemson. USC has to catch up. Maybe think about extending Tobacco Road a little for their South.

Hill: I don't know how big the concentration of Buffalo Wild Wings is in the Carolinas but I do remember --

Muckerman: There's quite a few.

Hill: -- two years ago, when Tom Brady was first suspended by the NFL, and he was going to miss four games, and this was going into the fall of 2015, I do remember that on a conference call, there was an analyst who asked CEO Sally Smith, this analysts had the numbers and basically said, "Here's how many Buffalo Wild Wings locations are in New England. Tom Brady is going to miss," and he ended up appealing and not missing, but he missed the first four of this most recent season, but -- and I give credit to this analyst, he did his homework. It's just like, "Look, you have a bunch of Buffalo Wild Wings locations in New England. The star quarterback of the home team is going to miss the first four games. Are you factoring that?" Legit question.

Moser: I guess my question here is, Oregon is with Under Armour, too.

Hill: Wait a minute, Oregon? No, that's a Nike --

Moser: Is Oregon Nike? OK. I was just thinking, I saw something, I was looking at this headline, Oregon Signs Record-Breaking Apparel Deal With Under Armour, and --

Hill: Are you sure it's not Oregon State?

Moser: No, it says Oregon.

Hill: Because University of Oregon is Phil Knight's alma mater.

Muckerman: Their football field is Nike sole turf.

Moser: I'm aware! Let's go in and confirm this, but this is back from 2014, but Oregon signs record-breaking apparel deal with Under Armour. The deal was announced just hours after Phil Knight announced he would no longer allow Nike to be associated with Oregon, citing his frustration with a lack of national championships.

Muckerman: This isn't The Onion?

Moser: No, this is SB Nation. [laughs] I guess Phil Knight got sick of a bunch of losers! And he decided to bag it. If that's the case, how interesting that you would then have two representatives of Under Armour and two of Nike.

Muckerman: So, Gonzaga and Carolina obviously --

Moser: Carolina is Nike, and I think Gonzaga is too. Oregon is the one I was questioning, because South Carolina is definitely Under Armour, and I think Oregon is, too.

Muckerman: Michael Jordan hasn't eschewed Carolina just yet, I guess.

Moser: That's pretty cool.

Hill: Yes. And the University of Oregon women's team is in the regional final that's being played tonight. They're playing UConn.

Muckerman: I'm so sorry for them.

Moser: Right, I was going to say, why don't they just hand them the trophy? It's Connecticut, can they really ...

Hill: You know what? That's what amazing Cinderella stories are made out of.

Moser: At some point, everybody thought Kentucky was going to win, but Wisconsin, was it Wisconsin?

Hill: Yeah, back in the day, a couple years ago. Look, if Goliath was undefeated, where's the fun in that? We need David to knock off Goliath every once in awhile. So who knows? The lady Ducks might get it done against UConn.

Muckerman: Lady Ducks and the Gamecocks. 

Hill: That's your lead story, by the way, if the UConn women don't end up winning the national championship. All right, Jason Moser, Taylor Muckerman thanks for being here, guys.

Muckerman: Cheers!

Moser: Thank you!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening, we'll see you tomorrow!