Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) capital allocation policy, or lack thereof, has been a major focal point for criticism. For years, Wall Street analysts saw the company as undisciplined, spending lavishly on noncritical projects the company affectionately called moonshots.

In recent years, Alphabet has taken the criticism to heart, first by hiring Ruth Porat as chief financial officer. The former CFO of Morgan Stanley has instilled budget discipline by cutting spending on noncore projects. Still, the company continues to invest in viable moonshots in its Other Bets division. Its newest announcement shows how the company's balanced approach to these projects is starting to pay off.

Balance scales with blocks spelling Risk on one side and Reward on the other.

Image source: Getty Images.

Project Loon enters the monetization phase

No project symbolized both the creativity and risk of Alphabet's Other Bets division like Project Loon. When the project, which entailed providing internet and wireless telephone access via solar-powered balloons, was first revealed, many characterized the idea as certifiably insane. Although fewer commentators questioned the technology after Alphabet's proof-of-concept tests in New Zealand, skeptics continued to doubt Project Loon's commercial viability.

Alphabet's recent announcement that it has signed its first commercial contract is big news for its Other Bets division. The company is partnering with partially state-owned Telkom Kenya to provide 4G coverage to remote areas of that country starting in 2019.

While the financial details were not disclosed, the project's move into a monetization phase should be comforting to investors considering the negative attention Alphabet's Other Bets segment has received.

Porat's effect on Other Bets

While it's often reported Porat is taking an axe to projects in Alphabet's Other Bets section, the truth is more nuanced. She has stemmed the growth in operating losses in the division: In the year before her arrival, 2014, operating losses in the section ballooned nearly 270% from the prior year despite robust revenue growth. Although operating losses continued to increase throughout her first year, they significantly slowed in the next two, with losses narrowing in 2017:

Chart of Alphabet's revenue and operating income attributable to its other bets segment

Author's chart. Data from Alphabet's 10Ks

At the same time, revenue continues to grow. Revenue attributable to Other Bets has increased from $12 million in 2013 to $1.2 billion in fiscal 2017, for annualized growth of 216%. Look for that trend to continue as Project Loon and earlier investments enter the monetization phase.

Narrowing losses in Other Bets could boost Alphabet's stock

While the Other Bets division is a minor part of overall sales, it's a drag on earnings. Last year operating losses in the segment were $3.4 billion, not an insignificant total considering Alphabet posted $26.1 billion in total operating income. Throughout the first six months of fiscal 2018 Alphabet has grown revenue in Other Bets 28% while continuing to narrow operating losses.

If Alphabet's newest announcement is any indication, investors can expect more growth and narrowing operating losses from this division. The combination of revenue growth from the monetization of prior projects and more-disciplined spending in the segment will continue to narrow losses and make it easier for growth from the much-larger Google segment to hit the bottom line.


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