The government continues to go after the big technology companies. In September, the Department of Justice's (DOJ) antitrust case against Google's search engine monopoly began its trial, with testimonies from various business leaders illuminating the workings of the important sector. Alphabet (GOOG 9.96%) -- parent company of Google -- has an estimated 90% share of the search engine market and has wiped the floor with any competitor for years. The DOJ is arguing that its distribution deals with hardware makers like Apple harm competition and unfairly enforce its monopolistic position.
While antitrust cases can lead to regulation and future profit losses, strangely, in this case, Alphabet may actually benefit if the DOJ wins its antitrust suit. Here's why.
What's actually happening
This DOJ case centers around three technology giants: Apple, Alphabet (Google), and Microsoft. There are a few other parts to the suit, but the most important topic by far is Alphabet's distribution deal with Apple. Alphabet pays Apple a handsome sum every year -- some estimate upwards of $20 billion -- to have Google be the default search engine on its Safari browser. This does not make Google the only search engine Apple users can try, but the one that is pre-installed onto the Safari engine.
With over a billion Apple users around the globe that skew toward higher incomes, Google finds it valuable to pay Apple this fat distribution tax every year. It hasn't hurt its profitability one bit, with its overall operating income hitting $22 billion just last quarter. The company also pays a distribution tax to other hardware makers, such as Samsung, although a much smaller amount.
So, where does Microsoft come in? As second in market share with its Bing search engine, executives at the company argued at the trial that Google and Apple's agreement unfairly cements them as the dominant search engine on mobile devices. In fact, Microsoft admitted that it offered Apple a deal to have Bing be its default search engine but couldn't make the economics work like Google. They and the DOJ are arguing that this is an unfair agreement that no other company in the world can match, even one the size of Microsoft.
Why Google wins (even if it loses)
If the DOJ prevails in its case, Alphabet may be forced to stop paying Apple, opening it up to more competitive threats. Investors may see this as a sign of a weakening competitive advantage and a risk for Alphabet shareholders as Google Search may start to lose market share to other search engines, such as Bing or DuckDuckGo, around the world.
But let's reiterate: This outcome would force Alphabet to stop spending tens of billions each year on search engine distribution. If the DOJ wins, Alphabet will eliminate all of this money from its operating expenses each year. Of course, if it loses more in revenue than it saves in expenses, this will be a net loss for Google. There are also rumors that Apple is working on its own search engine as a backup plan if the Google distribution agreement falls through, which they would clearly default to on Apple devices -- scary stuff.
Good news for investors: We have historical evidence of how successful Google can be when competing with an integrated search engine provider. Today, Google has just under 85% market share in search for desktop computers. Microsoft's Windows operating system is one of the leaders in the desktop computing space and defaults users to its Edge internet browser and Bing search engine (some may argue anticompetitively, but that's another story). The company has also apparently spent $100 billion over the years on its Bing segment to try and gain market share.
If Google search gets back to a level playing field competitively -- or perhaps even disadvantaged on Apple if it releases an in-house search engine -- investors shouldn't worry about the company losing much market share. The company has locked in users for years due to free services such as Gmail, Google Drive, Chrome, and Google Maps that connect back to the Google Search engine. This is why the company succeeds on Windows even though Microsoft defaults to its Bing search engine. I wouldn't expect anything different on Apple devices.
To sum things up, if Alphabet and Apple win this lawsuit, Google will retain its current position. If they lose, Google will likely only lose a little bit in market share. Neither scenario should hurt Alphabet financially. In fact, one might argue that the company will generate even more earnings if it stops paying so much in distribution fees every year.
AAPL Operating Income (TTM) data by YCharts.
The real loser may be Apple
Counterintuitively, the company that may actually get hurt here is Apple. Apple's distribution tax on Google is $20 billion in revenue it earns every year with virtually 100% profit margins. Over the last 12 months, it generated $112 billion in operating income, meaning the Google tax is an estimated 18% of Apple's overall profits if the $20 billion payment figure is accurate. If that goes away, its operating income will immediately fall by that 18% number. Shareholders will not like this.
The DOJ lawsuit against Alphabet may shake up the big tech landscape. Just not in the way you think. Apple is at more risk here financially than Alphabet.
