Google Is The Microsoft Of Mobile

| About: Alphabet Inc. (GOOG)

Despite the admission of failure with Motorola, Google (NASDAQ:GOOG) investors shrugged it off for the earnings report and focused on Google's outstanding growth in calendar 2013 Q4, fueled mostly by mobile. Borrowing from the Microsoft (NASDAQ:MSFT) PC playbook, Google has created the ultimate commodity computing platform in Android and a money machine for years to come.

Impressive Growth

While Apple (NASDAQ:AAPL) was stuck in the earnings doldrums in the last three months of 2013, Google was posting explosive growth. Excluding Motorola, Google's quarterly revenue grew by nearly 22% to $15.7 billion. Operating income (GAAP) for the quarter grew by over 18% to $4.429 billion, also excluding Motorola.

Given that the PC market declined overall in 2013, it's clear that most of the growth in Google's advertising business came from mobile users. Another indication of this was the nearly doubling of revenue for the "Other" category to $1.647 billion, which Google execs stated was driven by growth in Google Play, Google's Android app and content marketplace.

Google's growth is testimony to the importance and value of Android's new device sales market share dominance. What about usage share? That also is trending up, as can been seen in the following table from netmarketshare.com:

Borrowing from the Microsoft Playbook

Google accomplished its mobile dominance by borrowing from the Microsoft commodity PC playbook:

  1. Following Apple's launch of a revolutionary new computing OS, cobble together your own version to compete with Apple. Don't fret about the fact that it's inferior, just make it cheap enough that consumers won't care.

  2. Recruit as many manufacturers as possible to make devices with your OS. This gives consumers the impression that there is more choice and variety with your OS.

  3. Gradually improve your OS over a period of years until most people can't tell any quality difference between yours and Apple's.

Google even went Microsoft one better, by giving Android away for free. It could afford to do this because:

  1. Android was based on Linux, an OS that was already free.

  2. Google's main revenue stream is advertising on computing devices that use Google search or web-based services such as YouTube. Google only needed to increase the audience for its advertising.

Google's successful variation on the Microsoft commodity PC paradigm meant that when Microsoft tried to break into mobile with Windows 8 and Windows 8 Phone, it no longer had a paradigm that worked. Microsoft tried to repeat its tired old PC model, where manufacturers dutifully lined up to license Microsoft's OS. The license fees Microsoft charged put Microsoft's client OEMs at a cost disadvantage relative to Android. In the case of Windows Phone, Microsoft ended up giving the OS to Nokia essentially for free, by virtue of "platform support" payments it paid to Nokia. Windows couldn't become the predominant commodity mobile OS because there already was a less-expensive one.

The Motorola Aberration

With such a successful business strategy, why did Google bother buying Motorola? Investors never got a clearly articulated strategy for the acquisition, other than the usual platitudes about "synergy", a word that should be stricken from the lexicon of corporate management. Most point to the Motorola patent portfolio as the key motivation, but Florian Mueller, an intellectual property attorney, has pointed out on his blog that the Motorola patents haven't been particularly useful as a legal defense for Google.

The $12.5 billion that Google reportedly paid for Motorola was clearly more than it was worth. The Economist reported an interesting observation about how the valuation of Motorola might have been arrived at:

Using one of the industry's recent patent auctions as a baseline, in December of 2010, Novell sold off its portfolio of 882 patents for $450 Million. A simple division calculation leads us to a value of $510,204.08 per patent. Why not round that figure off you ask? Well, let's look at the patent value of the Motorola acquisition.

Forgetting that Motorola also makes mobile phones, let's say the entire value of the acquisition was in their 24,500 patents and applications. At a $12.5 billion price tag, that equates to…drum roll please…$510,204.08 per patent. Can anyone guess what heuristic they used in the board room in valuing the deal?

In the Motorola acquisition, Google bought a patent portfolio and got a mobile phone business thrown in for free.

But the mobile phone business has hardly been free, racking up losses every quarter since the purchase closed, including the latest quarter. For 2013 Q4, Motorola posted a GAAP loss of $507 million on revenue of $1.151 billion. All told, considering the money received from the Motorola Mobility and Home sales and losses posted by Motorola as part of Google, I estimate that Google will have paid about $9.7 billion for the patent portfolio, which it will retain. As of early 2013, Google only valued that portfolio at about $5.2 billion, as disclosed on pages 76-77 of Google's 2012 annual 10K SEC report.

A Lesson Learned?

Following the Motorola debacle, I would have thought that the takeaway for Google management would be, "Hey, we're a software company. Let's focus on making great software." But there's no indication of that in anything I heard on the conference call, or in Google's recent acquisitions of Nest and a number of robotics companies. It's the seeming lack of a coherently articulated vision for Google's future that bothers me. But even with that caveat, Google's near-term future looks bright, with Android-assisted growth of about 20% per year for the next few years.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.