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Are Alphabet's Other Bets Losers?

By Adam Levy - Feb 19, 2016 at 12:13PM

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Alphabet broke out Google from its other projects last quarter, and the results weren't great.

Image source: Flickr/Steven Depolo

There's a reason venture capitalists invest in so many different companies: It's hard to tell the winners from the losers.

Alphabet (GOOG -0.27%) (GOOGL -0.21%) has one sure winner on its hands: Google. But its Other Bets aren't so clearly winners. Other Bets consists of a lot of businesses, the biggest three being Nest, the smart thermostat company; Fiber, its gigabit Internet company; and Verily, its life sciences business.

Last quarter was the first time Alphabet released details breaking out Google from its Other Bets. In 2015, Other Bets contributed $448 million in revenue, but $3.1 billion in operating losses. Many of Alphabet's bets are pre-revenue, which is certainly dragging down its profit numbers, but even the more established companies aren't growing very fast.

Long-term value creation
During Alphabet's earnings call CFO Ruth Porat told analysts, "We're focused on optimizing resources across this portfolio in the near term with the objective of maximizing Alphabet's long-term value creation." In other words, investors shouldn't expect very positive results from Other Bets for some time. With that in mind, let's look at what's happened over the past couple of years.

Revenue grew just 37% in 2015, mostly coming from Nest, Fiber, and Verily. While that's strong revenue growth for a lot of businesses, remember that Nest, Fiber, and Verily are all young companies with huge potential markets. That kind of revenue growth is uninspiring, especially considering the expenses those companies rack up.

Fiber is one of the more expensive businesses. Porat points to Fiber as the source for the majority of Other Bets capital expenditures in 2015, which totaled $869 million. Note that Fiber only operates in nine cities and plans to expand to five more while exploring its options in 11 others. Those operating expenses are set to balloon in the next few years, and it's not clear revenue will keep up.

Operating losses nearly doubled from 2014 to 2015. Porat pointed to "project milestones" as one of the reasons expenses increased so dramatically last year. When asked about those milestones, however, she dodged the question.

So, where is this all going?
Alphabet's Other Bets numbers aren't moving in the right direction, and that leaves a lot of unanswered questions for investors. Can we expect these "milestones" to continually have an impact on expenses in the future? Will Fiber capex result in acceleration of revenue growth or not? How big of an R&D impact are pre-revenue projects producing in X, Alphabet's experimental division, and when can we expect them to produce results?

Right now, Alphabet's Other Bets are massive losers in aggregate. Capex is growing faster than revenue, and operating losses continue to expand. As a stand-alone company, Google would have produced 14% more operating income than Alphabet in 2015.

If Alphabet intends to continue spending billions of dollars on its Other Bets and producing only mild revenue growth, management will need to provide investors with a few more details about exactly what's going on.

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