A mounting ‘techlash’ is hurting Alphabet’s profits, and one analyst says spinning off YouTube could be the answer (GOOGL)

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  • Google parent Alphabet reported third-quarter profits that missed Wall Street estimates on Monday.
  • Some analysts expect the tech conglomerate's earnings to suffer going forward as it continues to invest to grow its business.
  • As a mounting "techlash" and heightened regulatory scrutiny eat away at Alphabet's margins, selling off YouTube could be the answer, according to Needham & Company analyst Laura Martin.
  • Watch Alphabet trade live.

The rebuke of big tech is starting to take its toll on Alphabet's earnings. To Laura Martin, an analyst at Needham & Company, it's one of the biggest drags on the company's overall profitability.

"GOOGL's margins are structurally under pressure owing to; a) rising competition; b) "Techlash" in the US; and c) increased regulatory scrutiny and fines globally," Martin wrote in a note to clients on Tuesday.

Alphabet confirmed in early September that the Department of Justice is investigating the company over potential antitrust concerns.

But Martin has a potential solution. She says Alphabet should spin off part or all of YouTube in an effort to shrink itself and alleviate regulatory scrutiny.

Martin estimates that YouTube is worth about $300 billion, based on estimated 2019 revenue of $30 billion and a 10-times enterprise-value-to-revenue multiple. That's roughly one-third of Alphabet's current market value, which is roughly $894 billion.

"Regulators have decided that 'big tech' is bad, based on a simplistic metric of market cap," Martin said. "GOOGL spinning off 100% of YouTube into a $250-$350B market cap piece would result in each company being materially smaller."

Martin also sees a YouTube spin-off creating value for investors in the following ways:

  • Pure-play assets — such as YouTube — typically demand a higher price because they help investors balance exposure to risk by business line.
  • More data would be available on each business in order to meet the "materiality" threshold, which relates to the significance of an amount, transaction, or discrepancy during the auditing process.
  • Employee retention could improve with stock options in a company employees believe they could impact.
  • Increased accountability for the executives of each business on a quarterly basis.

In the third quarter, Alphabet reported earnings per share of $10.12, well below analysts estimates of $12.35.

The company said a decline in the value of its equity investments reduced earnings, as well as a $554 million charge to settle a tax dispute in France. Alphabet's profits also fell from $13.06 in earnings per share during the same period last year.

The company said ongoing strength in YouTube, mobile search, and cloud contributed to its 20% year-over-year revenue growth.

Shares of Alphabet are up more than 23% year-to-date through Monday's close.

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