Charlie Munger on Google’s moat – it’s huge … probably widest he’s ever seen

Buffett has famously said that one useful way to think about a business’s moat – its durable competitive advantage – is to imagine that you had unlimited resources to attack it.  If you still could not topple it, you would have found a business with a solid moat.

In Google’s case, this isn’t a hypothetical.  Microsoft has spent billions of dollars in a determined effort to put a dent in Google’s moat.  So far, all they have to show for it is heavy losses and only modest market share.  It is believed that a large part of Bing’s market share has come at the expense of search engines other than Google. Microsoft was recently embarrassed when Google discovered that it was copying Google’s search results.

Charlie Munger had this to say about Google’s moat. “Google has a huge new moat. In fact I’ve probably never seen such a wide moat.”

Why?

It’s useful to think about Google’s moat the way you would think about the moat of a dominant city newspaper in the pre-Internet era.

NEWSPAPERS – THE READER’S PERSPECTIVE

For readers, the newspaper was the only game in town for keeping up with local news and an essential tool for buying a car, getting a job, learning about retail sales events, and an almost limitless number of niche activities.  Reading the paper was also quintessentially habit forming: pleasurable, repeated daily and low cost.

If you use the Internet, Google is a basic essential tool.  Its value lies in letting you navigate the Internet in a rational fashion, whether you’re looking to buy a new camera or need to know the capital of Uzbekistan.  This value grows as more information is placed on line – something that is happening at a dizzying pace – and as Google’s search algorithm improves.  Google is maniacally focused on improving its search engine and it benefits from having by far the largest number of searches to analyze and learn from.

It tells you something about a company when the company’s name becomes a verb that is synonymous with the underlying function it performs. Could you “xerox” that for me?  Google has this kind of mind share.

If you’re Bing, you can’t attack by lowering the price to customers. Google is free. At one point, Bing even tried paying people to search. There is no easy lever to disrupt the habit of going to Google each day to navigate the web.

NEWSPAPERS – THE ADVERTISER’S PERSPECTIVE

If you were an advertiser – auto dealer, employer, department store, furniture store, pretty much any local business – you needed to advertise in the newspaper because you had to be in front of your customers and that was the only cost effective way to do it.  The newspaper set the rate and you paid it.  Period.

Google is a must-have outlet for advertisers given its 65% share of U.S. search.  Its share is much higher in many international markets.  Advertisers not only pay for advertising but also work hard to optimize their sites so they show up at the top of searches on important key words.  A recent tweak in Google’s search algorithm showed the lengths that companies will go to rise in the search rankings.  A company can see it’s sales materially reduced if it falls in the rankings.

Google’s advertising is superior to that of traditional media because it is targeted and the results can be quantified.  More value means happier advertisers.  That rates are set by auction helps mitigate accusations of monopolistic price gauging which were frequently heard in the “old days” from newspaper advertisers.

A dominant daily newspaper’s growth was constrained by the development of the local economy.  Google is not constrained by local geography and is riding two huge secular waves: the transfer of advertising dollars to the Internet and the ever increasing adoption and usage of the Internet.

Regulatory risks swirl around Google but the threat to its core search business seems remote. Because Google’s business is based on technology, there is a some risk of disruption from creative destruction.  However, Google is determined to stay ahead in search and it has plenty of cash to purchase start-ups with a better idea.

Recent price: 524.20

Cash per share: 113.00

Cash adjusted price: 411.20

2012 consensus EPS estimate: 39.91

2012 cash adjusted earnings yield: 9.7%

 

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16 thoughts on “Charlie Munger on Google’s moat – it’s huge … probably widest he’s ever seen

  1. andy

    You should revisit your assumption of giving full value to the cash. To bring it to the US your gonna have a 35% haircut.

    Additionally, that excess cash has a high probability of being used to dumb foreign acquisitions or to fund projects that will protect Google’s search moat.

    Reply
    1. Greg Speicher Post author

      andy, you make a valid point. I wanted to give a quick back of the envelope earnings yield calculation. A more detailed analysis would certainly consider the issues you raised. I believe there is a possibility of doing dumb things with the money, but I’m not ready to conclude its a high probability.

      Reply
  2. O. Rolle

    I like this article! First it applies the idea of classic moats on tech companies. The aspect of market share is one important part of an IT company moat. But there are others: (1) the time a (software) product is used by customers and (2) openness of the system. (1) Google Software-as-a-Service (SaaS) is a good and bad example. Its good because customers do not switch to Bing because they are used to use Google. Its bad, because it does not cost the customer anything to switch to Bing (maybe thats why they offer other services like email and documents to increase their switching barrier). A typical example for a moat based on the time a customer uses an information system (IS) are IS in banks. Some of are older than 20 years and the bank could not change to later IS because all of their IT is build on top of it and the change is very costly. As a producer of these IS (like IBM) it is a cash cow. The banks pay every year millions for licenses, while the only cost center is software support.
    (2) An other aspect is the openness of an IS (IS as an ecosystem) without loosing the control over it – current example: iOS (Apple) and Android (Google). The core of this moat is, that an IS (eg. Android) attracts other software producers (eg. Manufacturers, App-Developer) which extend the IS with plug-ins and extensions. A decade ago Microsoft won against Apple because MSFT allowed users to install third party applications – Apple did not. But this tactic is only useful if a company has a strong competition in a market.

    I hope I could deliver my opinion and I apologize for my English. I am still learning it and I know only with practice I am getting better (thats why I wrote this comment ;-).

    Reply
  3. Greg Speicher Post author

    O. Rolle, thanks for the comment and your insights. You mention it does not cost anything to switch from Google to Bing. This is true, but it also does not cost anything to switch from Coke to RC Cola or a generic store brand. The challenge is to actually get people to do it. The daily habit of using Google acts as behavioral reinforcement.

    Reply
  4. James

    What about stock option dilution? I haven’t looked lately, but it used to be 25 percent. If you increase share count by that much, which you must since there’s no chance they wouldn’t allow them to vest (I.e., options repricing in bear markets), then the stock doesn’t seem so cheap. What do you think?

    Reply
    1. Hester

      Agree with Andrew Schneck, I’m an avid follower and read whenever it hits my RSS, but have never commented. But this article is one of the best of yours I read.

      Reply
  5. Greg Speicher Post author

    There were about 11 million options outstanding as of 12/31/10 on a basis of about 322 million shares outstanding. It’s not too high and necessary to maintain top-tier engineering talent.

    Reply
  6. Pingback: Does Google deserve a high multiple? | GregSpeicher

  7. Ricahrd Gordon

    Brilliant article Greg. I always love it when I read an article like this that gives me new insights and understanding to the mysterious world of investing. Thanks for the article.

    Reply
  8. Pingback: “The Freight Train That Is Android”; more on Google’s moat… | GregSpeicher

  9. Hari

    Great article even it is 16 months later. Has Google’s moat gotten stronger or weaker in the last year? Are the recent patent wars a distraction or a way of protecting the moat? As a user I feel it is the former but as an investor I see why the need to enforce patents. Would like to hear your thoughts.

    Reply
    1. Greg Speicher Post author

      All in all, I think it difficult to make a clear determination whether Google’s moat is stronger now. Certainly the success of Android puts another wall around the search castle and Google’s efforts in mobile are positives. And the secular trends described in the article are, I believe, very much in tact. There are probably greater regulatory concerns in the U.S. and Europe as Google’s presence and market power expands. Keep an eye too on valuation; the margin of safety is less today, but still reasonable given Google future prospects.

      I have planned to do an updated “deep dive” into Google to refresh my thinking. Perhaps this will give rise to another article on this subject.

      Reply

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