Until recently, some investors thought that Alphabet's (NASDAQ:GOOGL)(NASDAQ:GOOG) self-driving car business, Waymo, was worth over $100 billion. It hadn't generated a profit yet and barely even generated revenue, but the thought was that Waymo was so far ahead with its autonomous car technology that it would eventually grow into an enormously valuable autonomous ride-hailing business.

But earlier this month, news broke that Waymo had raised capital from outside investors for the first time at a much lower valuation, and management may be rethinking the unit's business model.

What happened?

Alphabet's Waymo LLC raised $2.25 billion of outside capital from a group of investors led by Silver Lake Partners, a private equity firm. This comes on the heels of Alphabet's fourth-quarter 2019 conference call, in which CEO Sundar Pichai telegraphed these intentions by stating:

Many of our "other bets" are getting to the stage where it now makes sense for them to partner closely with other players and investors in the industry. Waymo's technological leadership is widely reported. Its cars have driven 20 million miles across more than 25 U.S. cities. Waymo is now serving over 1,500 monthly active riders in Metro Phoenix and continue[s] scaling fully driverless by matching early riders with driverless vehicles and charging for these rides. As Waymo looks to its evolution as a business, it's focusing on strategic partnerships. For example, it's working closely with OEMs and other businesses to build out ride-hailing and delivery business lines.

A Google skateboard.

Image source: Alphabet.

Alphabet's "other bets" segment has had a cumulative operating loss of about $20 billion over the last six years. Management has decided it's at the point in its evolution where it can't continue to pump billions of dollars into these projects by itself for many years without a clear path to a payoff. 

In a recent interview with Fortune magazine, Pichai agreed that the company is now instilling more investment discipline on these moonshot projects and that the company is "at a phase where, while we take a long-term view, we also want to marry that with the discipline of making sure they are doing well." 

At what valuation?

While neither Alphabet nor Waymo disclosed the valuation of Waymo implied by the external investment, the Financial Times reported it was "over $30 billion." If accurate, that is a meaningful discount from the valuation of over $100 billion that has been thrown around in the last few years. For example, Morgan Stanley had valued Waymo at $105 billion late last year.

The big difference is that management now appears to be acknowledging that Waymo isn't going to be able to perfect the autonomous technology, roll out a global autonomous taxi business, and develop autonomous trucking all by itself. That would be too expensive and take too long. Instead, Waymo may scrap the development of the autonomous ridesharing business altogether and instead simply provide the technology and brains -- referred to as the "driver" -- for another company to use in its autonomous fleet. It's possible Waymo could partner with Uber and/or Lyft in developing this service since they already have established networks of cars and customers.

This new approach is much less expensive for Alphabet, and losses in the "other bets" segment will probably shrink as a result, increasing the company's reported profits. This lines up well with Pichai's new compensation arrangement, which will provide him substantial performance compensation based on Alphabet's total shareholder return over the next two or three years.

So what?

The bull case for Alphabet has been that the company's core search and ad business is one of the world's best businesses and is trading at a reasonable price. In addition, some of the company's big, promising businesses -- YouTube, Google Cloud Platform (GCP), hardware, and "other bets" like Waymo -- are not yet contributing profits and therefore appear to be thrown in for free. 

For those who thought Waymo was worth over $100 billion, or even $175 billion, this news is certainly disappointing. But a $30 billion business that's the leader in this cutting-edge technology is nothing to sneeze at. Investors should consider that the new external capital and partners may be able to help take Waymo to the next level over time, while also improving the company's profits.