Shares of Google-parent Alphabet (NASDAQ:GOOGL) Inc (NASDAQ:GOOG) dropped over 5% on Nov. 21 as prosecutors outlined certain proposals that would significantly alter how the search giant conducts its business. Soon after, Google shares rallied once again with the company introducing Willow, a quantum computing chip that promises to revolutionize the world in the long run. Investors, amid these exciting quantum computing developments, seem to have forgotten the threat posed by lawmakers. Trading at a forward P/E ratio of 25, Google is no longer cheaply valued from a historical viewpoint as the company has traded at an average P/E of 23.3 in the last five years. Given this rich valuation, a negative outcome from the antitrust trial may have significant implications for Google stock price in the foreseeable future.
In September, a court ruling found that Google violated antitrust laws for having a monopoly over the search engine business. With the DOJ suggesting Alphabet to sell Google Chrome and share data with rivals, concerns about Google's future direction have suddenly come to light. Let's have an overview of the whole case process.
The background Google started its journey in Silicon Valley as a startup with an innovative way to search the emerging internet. Now, it has grown synonymous with the internet and is one of the wealthiest companies on the planet, with a market value of over $1 trillion and annual revenue exceeding $160 billion.
General search engines are primarily distributed on mobile devices and computers, which contain web browsers and other search access points. Over the last decade, internet searches on mobile devices have grown rapidly, surpassing searches on computers. As a result, mobile devices have become the most important avenue for search distribution in the United States, making them an essential tool for businesses to reach consumers effectively. Google understood the importance of being the default mobile search engine, and to ensure this, the company has aggressively partnered with mobile device manufacturers. As the below chart illustrates, Google's dominance has remained unrivaled despite the threat posed by the rise of generative AI applications such as ChatGPT.
Google, through its flagship Chrome Browser, which is a widely used browser with over 3 billion users, controls nearly 90% of global searches. The popular Chrome browser is the gateway to Google's largest revenue source, ad revenue. Chrome has also played a key role in introducing users to Gemini, the company's own AI offering. Through Gemini, the SE summarizes search results and delivers more personalized experiences. According to Bloomberg, Chrome may fetch a valuation as high as $20 billion if the company decides to sell the browser to settle the lawsuit with the Justice Department.
Progress of the case The Justice Department filed its landmark case in 2020, alleging that Google monopolized the general search market by creating strong entry barriers and a feedback loop that sustained its dominance. DOJ accused Google, saying it has used anticompetitive tactics to maintain its monopoly in the market for general search services, search advertising, and general search text advertising, turning them into its cornerstones.
Google has recognized that the preset default general search engine is the most effective distribution method for mobile and computer search access points, as users rarely change the default, resulting in de facto exclusivity, especially on mobile devices where defaults are particularly sticky. Google pays tens of billions of dollars in payments to ensure it remains the default search engine to leading smartphone brands such as Apple Inc (NASDAQ:AAPL) and Samsung Electronics Co Ltd (KS:005930).
During the trial, Microsoft Corporation (NASDAQ:MSFT) CEO Satya Nadella provided testimony highlighting Google's market dominance, revealing how Google has become everyone's daily life ritual. Microsoft's Bing search engine struggled to compete because Google had secured default placement agreements across multiple platforms, said the CEO.
Resolving the case In September, Judge Amit Mehta of the U.S. District Court for the District of Columbia ruled in favor of DOJ that Google had committed an illegal monopolization of the search industry. The court found that Google violated Sections 1 and 2 of the Sherman Act, which outlaws monopolies. Elaborating on this decision, the court wrote:
Google has manipulated its control of Chrome and Android to benefit itself while sharing monopoly profits under conditions to induce third parties across the ecosystem to help Google maintain its monopolies.Separation of the firm, regulation, and business restrictions are some of the proposed options that could be used to redress this problem. Other prosecutors have even suggested that Google share its user data with competitors. The DOJ also wants the company's deals with pixel smartphones ceded, as the company is also known for its longstanding competition with Apple in the struggle for browser dominance and smartphone sales. The judge has set the trial on proposals for April 2025, and Google will present its proposals later this month.
In a filing, the DOJ wrote:
To remedy these harms, the [Initial Proposed Final Judgment] requires Google to divest Chrome, which will permanently stop Google's control of this critical search access point and allow rival search engines the ability to access the browser that for many users is a gateway to the internet.Additionally, the DOJ suggested limiting or prohibiting default agreements and revenue-sharing arrangements related to search and search-related products.
The DOJ also said that throughout the 10 years of proposed remedies, Google should avoid emerging competitive threats through acquisitions, minority investments, or partnerships. The filing further highlights that the proposed remedies are designed to end Google's unlawful practices and open the market for rivals and new entrants to emerge.
To restore competition, the DOJ wants Google to divest its Android mobile operating system as well, even as they recognize that such divestiture may draw significant objections from Google or other market players.
DOJ also expects Google to increase transparency and control for advertisers, end its unlawful distribution, and allow for the enforcement of the proposed final judgment while preventing circumvention.
Google's reaction Search accounted for $49.4 billion in revenue for Alphabet in the third quarter of 2024, representing nearly 55% of total revenue for the period. Alphabet CEO Sundar Pichai confirmed that Google pays Apple 36% of Safari search revenue under the terms of a default search agreement. Google spent nearly $49 billion in traffic acquisition costs in 2022, which includes all of Google's payments to Apple and Samsung to maintain itself as the default search engine. Pichai said the company pays Apple nearly $10 billion for this preferential treatment. Given the nature of the actions suggested by the DOJ, Chrome may soon lose preferential status in popular smartphone devices such as Apple iPhones and Samsung devices.
Google Chief Legal Officer Kent Walker condemned the suggested remedies, claiming that such measures would harm the security and privacy of Americans, hamper investments in artificial intelligence, and represent a striking overreach of government power. This decision, Walker claimed, would severely undermine consumers, developers, and small businesses and threaten U.S. economic and technological supremacy.
Google further added that such measures would hurt innovative services, like Mozilla's Firefox, whose businesses depend on charging Google for search placement. It will also deliberately hobble people's ability to access Google Search. As a final straw, the company added:
Mandate government micromanagement of Google Search and other technologies by appointing a Technical Committee' with enormous power over your online experience.Ironically, if Google aims to lower traffic acquisition costs', it may help boost Google's profits. Chrome's importance extends beyond its role in search, with related expenses amounting to $40 billion in the first nine months of 2024nearly 40% of Google's cost of revenue. Eliminating these expenses could significantly enhance the company's gross margins. Also, companies like Amazon.com, Inc. (NASDAQ:AMZN) have already been subject to their antitrust malice, making it difficult to find potential buyers for Chrome. Google is likely to appeal in the case.
Investors need to be cautious today Google's search business is at risk today due to antitrust regulations. However, this is not the only risk facing the search giant.
Conclusion None of the proposed remedies by the DOJ would bode well for Alphabet's business in the long term. Experts suggest that the DOJ appears to be leveraging this situation as a negotiation strategy to compel Google to agree to less drastic measures that help users switch to alternative search engines. If a divesture came to be, the transition period could likely create significant uncertainty and stress for many of Google's workers and shareholders. The court believes new technologies, including advances in artificial intelligence, may present an opportunity for fresh competition. The DOJ's request is one of its most combative attempts to break up a tech company since its 2001 antitrust case against Microsoft. Google's exponential growth in the 2000s was partly fueled by this resulting settlement of the Microsoft case.
In light of the mounting challenges faced by Google and its expensive valuation, long-term-oriented investors may want to take a step back today and observe new developments from the sidelines as there is a lot of uncertainty regarding the company's search engine dominance which has been key to its success in the past.