Alphabet’s valuation has risen in the past year, with the firm is now priced at 25x P/E and 20x EV/EBIT. These multiples are high for good reason: Google is a great business protected by a strong moat and its cash flows are growing quickly. But these multiples are elevated vs. the market, currently 20% higher relatively than they usually are, suggesting investors should consider reducing their position in the firm. I believe that would be a mistake, because Alphabet’s prospects remain strong when much of the market is struggling for growth. And it’s a mistake because Waymo is now the clear leader in autonomous driving systems, which is missed if we just analyze multiples. This raises today’s question. What’s Waymo worth?
Alphabet’s (GOOGL, GOOG) self-driving car project is usually acknowledged as the leader in a wide field of competition. Waymo has clocked up the most miles in testing (7mn at latest count and growing by 1mn per month).
Data from California’s DMV showed Waymo had the lowest rate of disengagements (human interventions) among firms testing in that state in 2017. Waymo has a public trial of their self-driving car service underway in Phoenix, AZ. And Waymo recently announced a partnership with Jaguar Land Rover for the auto firm to produce 20,000 electric, self-driving SUVs for Waymo’s transportation service.
Waymo’s future business model
There are three main capabilities required to launch this driverless service: (1) the operating system for the driverless car; (2) the customer relationships & optimization system to allocate cars to passengers wanting to use the service; and (3) the ability to build the cars rapidly.
Different firms specialize in these capabilities. I believe that building a consortium of firms who are leaders in their respective fields is strategically the best approach here, as this approach dramatically increases the chance of success. I believe that firms trying to do all functions within one entity, as it appears that Tesla is trying to do, will likely cause the firm to lose ground to the consortium of specialists.
Waymo is very well-placed for creating the operating system (1), it has relationships with Lyft & Uber for (2) and it seems they will likely partner with manufacturers for (3) as they have existing relationships with FCA (Chrysler) and Jaguar Land Rover.
Sizing the market
The opportunity here is enormous, but hard to quantify. The value to Alphabet will depend on what the transportation service ultimately looks like, who Waymo partners with, and when they can roll it out in scale.
I think it’s now clear that by 2030 many more people will be using transportation as a service (like Uber & Lyft, but not necessarily those firms), rather than driving themselves. The big difference from today will be that there won’t be a driver in the front seat, so the service will be much cheaper than Uber & Lyft are now, which will encourage adoption. I expect private cars will still be in use, but ownership rates may fall by half or more, with the balance being picked up by the transportation service that utilizes cars more efficiently.
The potential market is huge: Americans spent $1.1 trillion on transportation in personal vehicles in 2016. By 2030 I expect that at least 2/3 of this market will have transitioned to autonomous vehicles, and that the per-mile costs of this transportation will be cheaper than they are today, because it’s a more efficient system (lower cost vehicles, better utilization rates, & electrification) and the operators will pass some savings onto consumers to encourage adoption.
Waymo’s potential in 2030
This new self-driving market will likely be shared by several consortia that operate self-driving fleets, and then revenue will be shared by the firms within each consortium. But we’re still talking a large amount of potential value creation for Alphabet – consider the scenario here in which I estimate self-driving could comfortably create an incremental $25bn of EBIT for Waymo and ~$460bn of value for Alphabet in 2030.
Note that this is just the market in the United States. I expect Alphabet would be very well positioned to succeed in the home markets of the US’ traditional allies such as Canada and the EU. These opportunities would be incremental to the opportunity above, so the total value created could easily be 50% higher than that from the United States alone, which means the opportunity could be worth ~$700bn (in 2030).
Waymo’s value today
If we use that $700bn figure for the potential value in 2030 we should reduce it for (a) the chance that Alphabet doesn’t win in autonomous vehicles (see scenarios above) and (b) the time value of money by discounting the 2030 value back to today. I’ve done that exercise in the table above, and through it I believe it’s reasonable to value Waymo at ~$200bn today.
Alphabet remains a good investment
This valuation is uncertain, of course. My estimates above are not a forecast of what will happen, but more of an exploration of what might happen. I expect Waymo’s value will become clearer over the next 3-4 years however, which is within my investment timeframe, so I include this potential value in my analysis.
If we take that approach, then we can see that Waymo’s value means that Alphabet’s Google business is currently priced at <15x EBIT (see lower portion of the table above). I’ve repeated my valuation chart here, but with that 14-15x EBIT zone highlighted in red.
This exercise shows that Alphabet is not expensive once we take Waymo’s value into account. I believe that one of the reasons that Alphabet’s relative valuation has risen this year is because the market is ascribing more value to Waymo. I believe this will continue, which is one reason (among many) why I continue to hold the firm in the Cogent Alpha Portfolio.
Note: This article was originally published on Seeking Alpha on June 25th, 2018.