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The big costs behind Google's moonshot start-ups

Kate Drew, special to
Three reasons why Google changed its name
Three reasons why Google changed its name

If you want to know how much Google is spending on some of its wildest dreams, you'll have to wait a little longer than the first earnings report from Alphabet, the new name under which Google will report earnings for the first time on Thursday.

But that's only if you want to know what the damage is projected to be direct from the company. Alphabet isn't going to pull back the curtain on its moonshots — otherwise known as non-core businesses — until next January, but Wall Street has been busy doing some back-of-the-envelope math.

The debate among tech analysts isn't about whether the moonshots will lose money, but rather how large the losses will be. Estimates cited in a recent Wall Street Journal article range from as little as $500 million in operating losses to $4 billion a year — and separately, one analyst, representing the "high estimate on the Street," has placed a $9 billion price tag on Google's far-flung efforts.

In 2014, Alphabet's research-and-development expenses were $9.83 billion, or about 15 percent of revenue. By comparison, Apple spent $6.04 billion on R&D in 2014, a little more than 3 percent of its top line. Yahoo spent $885 million, or 18 percent of revenue.

"We have all this money, we have all these people. Why aren't we doing more stuff?" Larry Page, Alphabet's CEO, told Wired. "You may say that Apple only does a very, very small number of things, and that's working pretty well for them. But I find that unsatisfying."

The biggest difference between Google and Apple is that it's very clear what Apple's business model is both today and tomorrow, and investors have a lot of clarity about how Apple's individual product lines are performing, said Jan Dawson, chief analyst at Jackdaw Research.

Moonshots are typically associated with Google X, the company's lab for bolder (i.e., still losing money) initiatives. Besides its self-driving cars, the tech giant has dabbled in wearable computer systems and building artificial brains.

"Google is kind of becoming a portfolio management company," Dawson said.

That makes sense, but also highlights the challenge for company management.

"Right now investors really have no idea how the senior management at Alphabet/Google is making decisions about new areas to invest in, how long a leash these new businesses are given, how quickly they need to start producing revenue or profits, or ultimately what will determine whether Google continues to invest in these new projects if they're not meeting the company's goals," Dawson said. "It feels a bit too much as if Larry Page and Sergey Brin are being allowed to invest in pet projects without any broad strategic rationale behind them, and that would have me very concerned as a Google investor."

Justin Post, analyst at Bank of America, believes that other than the core Google business under Alphabet — which this week made its own investment in Chinese artificial intelligence company Mobvoi — only a few of Alphabet's other businesses are generating revenue. Those are Fiber, Nest and Dropcam, which Post estimates together will bring in about $400 million in revenue in 2015.

Citigroup analysts estimate a similar revenue range, while Evercore thinks revenue could reach above $800 million (or 1 percent of total net revenue for the company), with the majority coming from Nest, which should have $750 million in sales this year, according to Evercore. It also projects sales of $60 million for Fiber.

It feels a bit too much as if Larry Page and Sergey Brin are being allowed to invest in pet projects without any broad strategic rationale behind them, and that would have me very concerned as a Google investor.
Jan Dawson
chief analyst at Jackdaw Research

All the analysts agree that whatever revenue is coming in from select moonshots, it's going to be less than the overall costs attributable to the whole lot. Calico, the life sciences business, which has brought no drugs to market, and Google X are among the company's likely non-revenue-generating non-core businesses. Post's estimate calls for a loss of between $2.7 billion and $4 billion from such projects in 2015.

A few analysts think the loss could reach even higher than that. Brian Nowak at Morgan Stanley thinks losses from investment projects could cost Alphabet between $8 billion and $9 billion annually. For 2014 specifically, Nowak estimates that Alphabet lost about $8.98 billion on its side projects. As a percentage of revenue ($66 billion), that figure is about 14 percent. It's about 64 percent of the bottom line ($14.4 billion) — a pretty big number. But also one that's hard to put too much stock in — or serve as a reason to pull out of Alphabet stock — given the difficulty in doing this math with any confidence.

Evercore expects an EBITDA loss of as much as $850 million from non-core businesses, which would equal a 3 percent drag on overall EBITDA of $29.9 billion. Evercore estimates that the company will spend as much as $650 million of its R&D budget (10 percent) on Google X, resulting in an EBITDA loss of $900 million. The only "tangible" Google X product, in Evercore's opinion — Glass for the enterprise market — has sales estimated at $10 million.

What is Alphabet?
What is Alphabet?

The wide range in the estimates for the non-core businesses and Google X moonshots are a function of Google's secrecy about them.

"So many of these businesses — the economics are just completely opaque from the outside," Dawson said. "It's just a black hole at this point."

Google Alphabet.
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More clarity will arrive in January — that was part of the reason why Google restructured — but it's unclear exactly how much clearer the financial picture will become for each bold business line. Dawson said Google could either break out the financials for each project, the moonshot business as a whole, or some combination of the two.

Post thinks it will likely be a lump-sum figure, without much detail on the individual businesses. "I don't know that we're going to get much more detail than that," he said.

Dawson said that Google has to move beyond its core business as the challenges mount — the largest being the shift to mobile, and the accompanying shift from the Web to apps.

"Google has to be looking for the next big thing and to be investing heavily in that," Dawson said. "But in most companies, that investment would be in areas that seem like natural extensions of Google's existing business and that can leverage its existing skill sets and assets, whereas Google seems to be investing in such a wide range of projects with so little connection to its traditional business, that it's very hard to see a coherent strategy behind its investments."

For now, Dawson — the industry analyst rather than financial analyst — shrugs at all the Wall Street moonshot math for Alphabet. "We have so little information to go on, it's almost pointless to even try to guess at it," Dawson said.

Alpha — in the investment industry parlance — refers to the bets that generate a return in excess of the overall market return. Alpha is what top hedge fund managers get paid big bucks for generating.

And keep in mind what Larry Page told Wired: "We love big bets."

By Kate Drew, special to