The best technology doesn’t always win. If a company can’t get its technology to consumers, it will be beaten out by a company that can, even if its technology is inferior. This is the fundamental problem facing Waymo, Alphabet’s (GOOG, GOOGL) self-driving car subsidiary. Waymo doesn’t make cars, and doesn’t want to. It can only reach consumers through partnerships with car manufacturers. (Or by buying a manufacturer, but that seems off the table.)
Waymo, then, is a high-tech software company that is forced to partner with low-tech hardware companies in order to bring a high-tech product to market. This poses a considerable difficulty. The culture of a Silicon Valley company founded in 1998 could not be more different than the cultures of century-old carmakers. Communication and cooperation across the two cultures can become frustrated. Ford’s (F) failure to understand Alphabet’s culture is cited a major reason an attempt to forge a partnership between the two companies fell through. To date, Waymo has not reached a large-scale deal with any automaker.
Manufacturers want to acquire, not partner
What’s worse for Waymo, car manufacturers have a strong incentive to develop self-driving cars in-house. Since one self-driving car is expected to substitute for five to 10 human-driven cars, manufacturing will constitute a much smaller part of the automotive value chain as autonomous ride hailing swells to become the lion’s share. A manufacturer building cars for Waymo would be digging its own grave.
Much better would be for a manufacturer to acquire a Waymo-like entity. Seeing the opportunity, technologists have founded dozens of self-driving car startups ready to be gobbled up by the big auto companies. A few of these were founded by Waymo’s former employees. Notably, Chris Urmson, who led Alphabet’s self-driving car project from 2009 to 2016, co-founded a startup, Aurora Innovation, with Tesla’s (TSLA) former head of Autopilot, Sterling Anderson. For a company like Ford, acquiring a startup like Aurora Innovation is much more attractive than partnering with Waymo.
In fact, about a year after the talks with Waymo fell through, Ford acquired a majority stake in a self-driving car startup called Argo AI. GM (GM) made a similar move last year by acquiring the startup Cruise Automation. Self-driving car startups are not in short supply, so other manufacturers can follow suit. This makes Waymo dispensable.
GM’s Cruise Automation demonstrates its self-driving technology
Waymo’s way forward
As far as I can see, Alphabet has three options:
1. Buy a car manufacturer.
2. Sell Waymo to a car manufacturer.
3. Keep trying to partner with a manufacturer, with no guarantee of success.
While inertia favors option (3), it could end with Waymo becoming another failed moonshot. Option (1) seems unlikely. Acquiring a car manufacturer would cost tens of billions of dollars. It would be by far the riskiest move Alphabet has ever taken. Alternatively, Alphabet could simply cut its losses with Waymo and little harm would be done.
Option (2), then, is perhaps the best way for Alphabet to recoup its investment in Waymo and perhaps even make a several-fold return. However, if I were Alphabet CEO Larry Page, I would be reluctant to sell after working on self-driving cars for eight years and popularizing the technology, especially given the anticipated size of the market. The temptation for Alphabet, then, is to default back to option (3). Even if Alphabet did decide to sell, the payout would be constrained by what cash-strapped automakers with market caps much smaller than Alphabet’s are able to pay.
For investors seeking to capitalize on the opportunity that self-driving cars present, Alphabet is probably not the best option. While its technology may be the best in the world, it doesn’t have a viable path to bring that technology to market. Selling Waymo would not result in earnings anywhere near comparable to directly entering the self-driving market. Interested investors would be better off looking elsewhere.
Disclaimer: This article is not investment advice.
Disclosure: I am/we are long TSLA. 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.