Alphabet Inc.’s Google (NASDAQ:GOOG) (NASDAQ:GOOGL) is clearly in a tough spot right now. In addition to facing a possible decline in revenue growth due to the possible recession, the company is also risking losing a significant portion of its income if the legislators from both sides of the Atlantic pass new oversight regulations, which are aimed at stripping Google from its monopoly gatekeeper status.
While this is not the first time that Google faces new regulations, this time it seems that there’s a real risk that the company could lose a sizeable portion of its market share in the U.S. and the EU, which will make it challenging for it to continue to create additional shareholder value. Therefore, even though Google trades at a discount to its fair value today, as long as the regulatory pressure remains, investors shouldn’t expect a significant appreciation of the company’s stock anytime soon.
Google’s Fight For Survival Begins
This is not the first time that the legislators want to increase a regulatory oversight over the Big Tech. Back in 2019, I mentioned how Senator Hawley wanted to pass a bill that would’ve regulated the use of loot boxes and micro transactions in video games. While that bill has been stuck in the Senate ever since, it seems that new and harsher legislation now has a chance of passing in both chambers of the U.S. Congress.
The most prominent regulatory bill at this stage is The American Innovation and Choice Online Act. In late January, the bill passed the Judiciary Committee in a 16-6 vote. Currently, it has bipartisan support, as diverse groups of Senators from both sides of the aisle are its cosponsors. In its essence, the goal of the bill is to prohibit gatekeepers such as Google from giving preference to its own apps on its platforms, as it’s making it hard for other apps from third-party developers to compete on equal terms. The monopoly gatekeepers in this bill are called “covered platforms” that have over 50 million monthly active users from the U.S., while their parent company has a market cap of over $500 billion.
If passed, this bill would disrupt Google’s business model forever. Under the bill, if you were to look for some location on Google Search, Google Maps will no longer be your preferred option, as Google won’t be able to prioritize it above other map apps. At the same time, the bill would ban the use of non-public data of users to offer their own products. If Google collects some of your data via cookies on Google Chrome, it won’t be able to use that data to offer you its own services from the cloud, video, or other mediums that are tailored specifically for you. On top of that, the bill would prevent the restriction on uninstalling preinstalled apps. For example, if you were to purchase a phone with an Android OS that has Google Chrome already preinstalled, you should have an option to easily uninstall that browser if you want to.
If passed, the bill will give the FTC and the Department of Justice the power to determine covered platforms and enforce the regulation on them. If covered platforms breach the regulations, they will face sizeable civil penalties of up to 10% of their U.S. revenue, and could even be forced to forfeit their profits if they continue to break the rules.
Considering all of this, investors might wonder why this is important in the first place, and the answer would be pretty simple. For Google, digital advertising is its bread and butter. In Q1, the company generated $68 billion in revenues, out of which $54.6 billion came from advertising. The company is able to generate so much money from advertising thanks to its algorithms that collect user data within its ecosystem from various platforms such as Google Search, YouTube, Play Market, etc. Once the data is collected, Google better understands the preferences of its users and uses that data to either create personalized ads for its own products and services or sell the digital advertising space to advertisers who pay to use that data to showcase ads of their own products or services. Thanks to Google’s sophisticated algorithms that collect data from different sources, advertisers prefer to use the company’s advertising offerings, as it leads to a greater conversion rate.
Therefore, if the bill is approved, Google could potentially lose the ability to collect much useful user data from different sources and create personalized offerings, since it won’t be able to prioritize its own services over others where that data is collected in the first place. This could lead to a decrease in the effectiveness of ads that are run on its platforms and will force advertisers to look for alternatives, leaving Google with less income at the end of the day.
To try to stop the passage of the bill in its current form, Google’s CEO Sundar Pichai himself plans to visit Capitol Hill to meet with Congressmen later this week. On top of that, Google already has spent $3.5 million on lobbying in Q1 only. While this might sound like a big number, the potential fine that Google could face by breaching the possible new regulations is significantly higher.
From Google’s 2021 annual report, we know that in 2021 the company generated a total of $257.64 billion in revenue, out of which $117.85 billion came from the United States. If for example, the company was fined 10% of its U.S. revenues last year, then it would’ve been required to pay $11.79 billion for potentially breaching the new regulation, which accounts for 8.3% of its total cash reserves at the end of March. The potential loss is astronomical in comparison to what the company spends to prevent the passage of the bill.
While in the past Google managed to tone down the language of some regulatory bills, there’s a risk that it won’t be able to do so this time, as there’s an indication that both parties want to increase the oversight over Big Tech. Just last week, the Senate passed another bill, which gives state attorney generals the power to decide where antitrust suits could be heard. This will prevent Google from shifting cases to New York, as it did before if the House passes the bill as well.
On top of that, a month ago another regulatory bill was introduced. It’s called the Competition and Transparency in Digital Advertising Act and it also has bipartisan support in the Senate. Its goal is to prevent ad platforms, which generate over $20 billion in revenue, from making it possible to buy and sell ads at the same time. In other words, such ad platforms would need to break up or stop either buying or selling ads to continue operations. If passed, Google would no longer be able to use its digital advertising space to show its own offerings to users if it wants to provide the same advertising space to other advertisers. In addition, considering the revenue requirement for ad platforms, it’s obvious that Google is the main target of this bill.
Proponents of those bills will likely push for a vote in the Senate before the August recess, as later than that could be too late due to the midterm elections. The Senate Majority Leader Chuck Schumer is open to the idea of bringing them to the floor if there’s enough support.
Considering all of this, it seems that Google is at risk of losing the status of a monopoly gatekeeper, as the support for the greater oversight of the Big Tech continues to get more traction. If those bills are passed, we could safely assume that Google will lose a significant market share in the digital advertising business, which will undoubtedly lead to a decline in revenues. However, even if the company somehow manages to persuade Congressmen not to vote for those bills, there’s no guarantee that the following 118th Congress will do the same thing.
There Will Be Blood
What’s also worse for Google is that if it manages to prevent the passage of the new regulatory bills in the United States, it’s very unlikely that it’ll be able to do the same thing in Europe, given its shaky relations with the EU regulators. For those who are unaware, back in 2017, the EU Commission fined Google €2.42 billion for abusing its dominant status as the main search engine in the union by giving an advantage to some of its products over others. The company appealed the decision but lost the appeal in November of 2021.
Then in 2018, the EU Commission once again fined the company €4.34 billion after it found out that Google licensed Play Store to phones only after phone manufacturers pre-installed Google Chrome and Search apps there. The company has also filed for an appeal, and the European court will make a final verdict on September 14.
In addition, in 2019 the Commission has also fined Google another €1.49 billion for abusive practices in digital advertising when signing certain contracts with third parties, which prevented fair competition. Google is also appealing this decision, and the final verdict should be published later on.
In total, if Google loses the appeals in European courts, it will face over €8.2 billion in antitrust fines combined. While it is a big sum to pay, it seems that the worst for the company is yet to come.
In the wake of the Russian invasion of Ukraine, the European Union decided to begin working on a new security framework, which should not only include the union’s energy security strategy, but also its digital security as well. In March, the European Council reached a consensus with the EU Parliament on how to proceed in creating a new framework of regulations in the digital space.
The first proposal is the implementation of the Digital Markets Act, which is legislation that’s similar to the U.S. bill discussed above. The goal of this legislation is to force the gatekeepers to change their business practices by creating legal instruments that will prevent them from using their platforms to promote their other products over others. At the same time, under the proposal, the gatekeepers won’t be able to collect users’ data on one of their platforms and use it on their other platforms. So, for example, Google won’t be able to use data obtained from Google Search for YouTube recommendations. On top of that, the option to uninstall pre-installed platforms on devices is added to the proposal as well.
The core idea of this legislation is to strip gatekeepers from their monopolies by leaving them with less power and leveling the playing field. The fines for breaking the rules are also harsher than in the U.S. bills. If a gatekeeper doesn’t comply with the regulations – it’ll be forced to pay a fine that equals 10% of its total worldwide turnover. If a gatekeeper continues to break the rules – it’ll face a fine that equals 20% of its total worldwide turnover. So even though Google’s sales in the EMEA account for only 31% of total sales, it’ll be forced to pay the fine that equals the percentage from all of its activities around the globe.
The second proposal is the implementation of the Digital Services Act. Under this legislation, those digital platforms with over 45 million users will be required to improve the moderation of their content to prevent a flow of misinformation, and at the same time to disclose to the European users how their algorithms work. In Google’s case, it means becoming more transparent and describing how it collects the user data and how it uses it. If the company breaches the rules – it’ll face a fine that equals up to 6% of its total turnover.
Even though Google has been aggressively lobbying against those proposals as well by going as far as to mobilizing the European think tanks and creating conflicts between the European Commission departments, it seems very likely that it’ll lose this battle. Considering that the EU Council and the Parliament reached a consensus a few months ago and that Europe is more united than ever, it’s only a matter of time before the EU Commission finalizes texts for both legislations and sends them for the vote. If approved, which seems quite likely, both of those proposals will become laws sometime between 2023 and 2024. What’s also worse is that the same European Commission that has been fining Google all these years will have the sole power to enforce the implementation of those proposals on the gatekeepers.
If all of those legislations are passed and implemented in the following years, Google will have a hard time operating its business under the current model. By reading the proposals of the U.S. and European legislators, it becomes obvious that Google’s algorithms at the very least will become less effective for advertisers, which will force the company to lose its competitive edge. At the same time, since the U.S. and EMEA revenues account for 77% of total revenues combined, the implementation of those proposals will have an overreaching impact on the share price as well.
As a result, it’s even harder at this stage to find out a fair value of the business if those proposals are approved and later become laws in 2023 – 2024. Even though Google is currently undervalued according to the Street, as its consensus price is over $3000 per share, the analysts’ forecasts don’t include the possible losses of potential revenues from the implementation of those proposals, which would make those forecasts irrelevant if the legislators prevail. On top of that, even if the downside from the U.S. regulations is somehow mitigated, it becomes harder to believe that the Europeans will back off given their history of relationship with Google. Also, if in one of the scenarios those proposals are implemented but Google ignores them, it will be forced to pay astronomical fines, which won’t justify such behavior in the first place. Exiting Europe is also not an option, since it’s the second-biggest market after the United States.
Considering all of this, it becomes harder with each day to justify a long position in Google given the toxic environment in which it currently operates. Let’s not forget that Apple’s (AAPL) decision to change a simple tracking policy could cost Meta Platforms (META) $10 billion in lost revenue this year. A hundred pages of regulations from legislators from both sides of the Atlantic will undoubtedly cost Google more in the long run and will result in a disaster for its business in its current form.
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