Alphabet spends massive amounts of money on its "other bets" -- essentially, moonshot technology research in pursuit of the next big thing. These expenditures have been a consistent, and large, feature of Alphabet's financial statements for almost a decade.
However, a company that fails to responsibly invest retained earnings isn't doing right by its investors. Were such long-shot investments a one-time event, it wouldn't be a big deal, especially for a company with a monopolistic search engine that generates lots of cash. But over time, investors have to wonder if the company would have been better off using its moonshot cash to buy back shares, or make more directly accretive acquisitions.
But aren't tech companies supposed to innovate?
To be fair, Alphabet is a tech company. It's supposed to be working to advance technology, and management is right to be looking toward the future. After all, history is replete with tech companies that fell behind because of a failure to innovate -- think Xerox and Kodak. Believers in Alphabet's strategy realize that and support its search for the "next big thing," especially as competitors like Amazon are always looking for ways to build upon their ecosystems.
But these moonshots are largely unrelated to Alphabet's core business, or to Larry Page's stated goal of improving on artificial intelligence.
Take Project Foghorn, Alphabets initiative to convert sea water into a usable fuel for internal combustion engines. Had it worked, carbon emissions would have been drastically reduced and millions of cars would be able to stay on the road. Or its drone internet initiative, known as Titan, whose lofty goal was to provide internet service to the entire world. Then, of course, there's Google Glass. Basically, a headset that the user wears like a pair of glasses that displayed information to the user in a smartphone-like format right on the lenses. It technically worked but has been abandoned due to lack of public interest and privacy concerns -- Glass could also record audio and video.
Even if Alphabet were to hit a home run with one of these projects, shareholders won't necessarily benefit. Alphabet's Q3 earnings report showed that revenue for "other bets," which includes Nest, Google Fiber, and dozens of other experimental ventures, rose 53% year over year. Not bad, but the segment still reported an $861 million operating loss.
Tech innovation isn't as easy as A-B-C
The more I've learned about Alphabet's moonshots, the more I'm in awe of companies like Amazon that constantly innovate, but in ways that add to the value of the core business. Jeff Bezos was able to build Amazon Web Services into a huge cash cow for Amazon, yet you'd think simple Web hosting would have been something Alphabet would naturally dominate. In the last quarter ended September 30, 2017, alone, Amazon spent $5.94 billion on technology and content (basically Amazon's classification for research and development expenses that also include content for Prime Video), up from $4.14 billion in Q3 FY 2016. A huge sum of money, but there is a method to Bezos' madness.
The best example of Amazon's effective use of R&D expenses to directly add to its business is Prime. A membership costs $100 per year, but subscribers get so much more than free shipping. Bezos & Co. continue to build upon Prime's value, with things like free photo storage, food delivery via Amazon Fresh, entertainment through Amazon Prime Video, and larger storage options (for an additional fee, of course). As the list of benefits rises, it becomes harder and harder to say 'no' to a Prime subscription.
A "moonshot" success would probably be a massive boon for society. But one can't help wondering if Alphabet is ignoring an exceptional business in choosing to focus on spinning the roulette wheel.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Sean O'Reilly has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy.