With antitrust cases looming and the risk of breakup increasing, Google's valuation multiples have hit rock bottom. As management changes, how should Google use this transformative opportunity to regain investor confidence?
On September 18, Morgan Stanley's strategic analyst Brian Nowak and his team released a report, listing four things the new CFO of Google can do to enhance valuation multiples: increase disclosure on generative AI; provide guidance on revenue, operating expenses, and capital expenditures with upward revisions; disclose more comprehensive business segments for YouTube and GCP; emphasize Google's positive impact on society.
Morgan Stanley pointed out that Google's years of antitrust lawsuits could undermine its position in online channels. In addition, Google faces various pressures such as the risk of interruption in generative AI search, increased capital expenditures, high uncertainty in generative AI marginal return on invested capital (ROIC), and how to protect profits through operating expense management... At the same time, the market expects Google not to revise revenue guidance, leading to a lack of investor interest in Google's positive aspects.
Currently, Google's valuation multiple relative to the S&amp;P 500 is around 0.87 times, the lowest in a decade, while the long-term average level is 1.1 times.
<h2>01 Helping Investors Better Understand the Incremental Opportunities Brought by Generative AI</h2>
First, Morgan Stanley believes Google should consider providing more disclosure on incremental user engagement, revenue opportunities, and early signals of generative AI.
Disclosure will help investors better understand the sustainability of Google's capital expenditure growth and revenue growth. While Google has already shared comments on improving ad effectiveness, the market needs a deeper understanding of Google's adoption of new technologies and products to quantify the potential impact of these revenues on the profit and loss statement (P&amp;L).
Second, Morgan Stanley believes Google should maintain a high level of innovation speed and showcase new sources of innovation in its product portfolio.
The table below shows products that Google may drive return on invested capital (ROIC) in areas such as search, YouTube, and cloud computing, as well as new products and tools that Google is developing, entering testing phases, and gradually rolling out. As antitrust regulation may continue for several years, Morgan Stanley believes Google's ability to develop innovations, expand new users and advertisers is crucial to maintaining its leadership position in online channels.
<h2>02 Providing and Upwardly Revising Guidance to Enhance Investor Confidence in Free Cash Flow</h2>
First, Morgan Stanley believes Google should provide specific guidance on AI capital expenditures and free cash flow.
Amid the AI bubble controversy, the market closely watches the capital expenditure growth of large tech companies in generative AI for this year and the next two years. META provides future capital expenditure guidance, Microsoft provides comments on capital expenditures for subsequent quarters, and Amazon provides comments on annual capital expenditures
Compared to this, Google's capital expenditure commentary is too vague: &#34;Looking ahead, we expect capital expenditures for each quarter this year to be roughly flat or higher than the first quarter's $12 billion.&#34;
This vagueness, coupled with Google executives' previous statement that &#34;the risk of underinvestment is far greater than the risk of overinvestment,&#34; has led to strong uncertainty among investors about Google's free cash flow (FCF). Morgan Stanley expects Google's capital expenditures to be around $57 billion in 2025, which means generating approximately $8.20 of free cash flow per share. Based on this free cash flow estimate, Google's P/E ratio in 2025 is around 19.5 times, relatively low valuation, especially considering the company's expected free cash flow growth rate of about 21% from 2023 to 2026.
However, a 10% increase in capital expenditures will result in a roughly 6% decrease in free cash flow per share. Therefore, more detailed capital expenditure guidance will help investors better understand the range of Google's free cash flow.
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Secondly, Morgan Stanley believes that Google should quantify the benefits of further optimizing operating expenses (Opex) and commit to expanding profit margins.
Over the past 20 months, Google has successfully implemented multiple workflows, redesigned its operating expense structure, and leveraged investments. These transformations have made progress, with Google's operating expenses growing by about 6% in 2023 and profit margins increasing by approximately 230 basis points. Compared to internet peers, Google is at a moderate level in terms of operating expenses per employee and close to the upper limit in terms of revenue per employee.
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The question is, how will Google's management balance increasing efficiency, protecting earnings per share (EPS) and free cash flow, while increasing investments in generative AI.
Morgan Stanley believes that Google still has room to further improve efficiency. Although Google achieved leverage in 2023, in the previous 6 years, despite revenue growing about threefold, Google's profit margin only expanded by about 10 basis points in total. Therefore, providing clearer guidance on operating expenses, profit margins, and other quantifiable metrics can help investors understand Google's plans for optimizing operating expenses and more.
Finally, Morgan Stanley believes Google should issue quarterly guidance and strive to raise expectations.
Most of Google's peers such as Meta, Apple, Microsoft, etc., have issued quarterly guidance to help investors better understand the latest market trends, grasp the reasonable range of the company's future growth and profitability. Some companies even provide annual guidance.
Issuing guidance and continuously revising it based on guidance will enhance investor confidence in the company's business operations, etc., helping to drive valuation multiples growth and reduce valuation multiple fluctuations
<h2>03 Improving Business Disclosure for YouTube and GCP to Help Investors Understand Key Growth Areas</h2>
First, Morgan Stanley believes that Google should break down the revenue from advertising and subscriptions on YouTube.
YouTube's existing disclosures indicate that it generated approximately $31.5 billion in annual advertising revenue in 2023, with a projected 12.5% year-on-year growth in 2024. However, the subscription situation on YouTube is not clear. Google has been internally driving the growth of YouTube's subscription business, but due to limited disclosure, investors can only estimate that YouTube's annual subscription revenue in 2023 was around $15 billion.
However, Morgan Stanley believes that the current disclosure on YouTube underestimates its subscription business by about 50%, and overlooks its higher valuation multiples, as well as the more sustainable and stable characteristics of the business. Therefore, Morgan Stanley suggests that Google provide ongoing profit disclosures for this business to help the market better assess this business compared to other leading online video platforms such as Netflix.
Secondly, Morgan Stanley believes that Google should also break down Workspace and GCP business within Google Cloud.
The existing disclosures for Google Cloud indicate that it generated approximately $33 billion in annual advertising revenue in 2023, with a projected 31% year-on-year growth in 2024. However, this business segment includes both the Workspace business and the faster-growing and critically important hyperscale cloud computing business (GCP). While there are market estimates regarding GCP and Workspace, continuous disclosure will help the market better understand Google's development compared to AWS and Azure, especially in this crucial period of generative AI.
Morgan Stanley believes that execution and disclosure in this area are one of the biggest opportunities for Google's valuation multiple expansion, as well as an opportunity for investors to better understand the return on capital expenditure.
<h2>04 Emphasizing Google's Positive Impact on Society and Regaining Control of Public Narratives</h2>
Morgan Stanley believes that Google should actively promote its positive impact on society in various ways to regain control of public narratives.
As mentioned earlier, Google may face years of antitrust regulation in the future, and although disclosing information during legal proceedings may be complex, Morgan Stanley believes that Google at least has the opportunity to express its position more actively through press releases, blog comments, etc., and highlight its positive impact on society, users, advertisers, developers, small and medium-sized enterprises, and large enterprises.
Specifically, Google can learn from Amazon's practices to better promote its positive impact on the entire economic system. Amazon often issues press releases detailing the number of jobs it creates, investments in local communities, and income brought to third-party sellers.
For Google, millions of small and medium-sized enterprises use Google's platform to build businesses, the Android ecosystem and app store enable device manufacturers and developers to create billion-dollar businesses, over 1 billion people globally use free Google Maps, Google Translate improves global communication, and it is even used by doctors to save lives... There are many more examples like these
Google's products provide tremendous public welfare and utility to society, but its current valuation multiples do not reflect these values.

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Morgan Stanley believes that Google should increase disclosure of generative AI; provide specific guidance on AI capital expenditures and free cash flow, and revise quarterly guidance upwards; disclose more comprehensive business segments for YouTube and GCP; and emphasize Google's positive impact on society. These measures can help Google enhance investor confidence and increase valuation multiples

- Google’s valuation multiples have dropped significantly amid antitrust challenges and management changes, prompting a need for strategic actions to regain investor confidence.  
- Morgan Stanley analysts suggest that the new CFO should enhance disclosures on generative AI, provide clearer revenue and capital expenditure guidance, and improve transparency regarding YouTube and GCP's business segments.  
- Emphasizing Google’s positive societal impact could also help reshape public perception and support valuation recovery amidst ongoing regulatory scrutiny.

Morgan Stanley: Market disapproval, Google management has a responsibility, should do this!