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Android Is the Anchor for Alphabet's Ad Revenue Growth

- By Sangara Narayanan

Alphabet Inc. (GOOG)(GOOGL), Google's parent company, is one of the very few companies that can boast of double-digit revenue growth despite approaching a hundred billion dollars in annual revenues. Alphabet's total revenue has now grown from $16.5 billion dollars in 2007 to $90.2 billion in 2016. The growth of digital advertising has been tremendous during the last decade. Google captured most of that growth and continues to lead the segment, although Facebook Inc. (FB) is slowly trying to carve out its own place in the digital advertising market.


Alphabet has tried for a long time to diversify its revenue streams but, except for its recent cloud initiatives, there is not a single promising segment that can bring in additional billions for the company in the near future. The Google Cloud Platform has a lot of potential to grow due to its own expertise and the overall health of the industry, but it will be a few more years before Alphabet starts counting in the billions from GCP.

If you are an investor in Alphabet, though, you need not worry because Google has built a solid moat called Android around its advertising revenue stream.

Android is not just the number one mobile operating system in the world, it is also the one operating system that is in a position to add millions of users to its fold over the next decade. Together, Apple's iOS (AAPL) and Google's Android are the two dominant forces in the mobile operating world, leaving nothing for the rest to have. Apple products are at the high-end, luxury segment of the device world, while Android is more focused on the middle to low-end smartphone segment.

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Smartphone penetration in developed markets such as the United States has already crossed the crucial 70% mark, indicating growth is going to be extremely slow from here. But there are several countries in the Asia Pacific region where internet penetration - and, therefore, smartphone penetration - is very low but rising at a steady rate. The market for iOS devices here is very small, while OEM Android phones will face no such problem.

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As internet penetration increases in developing countries, Android will continue gaining market share and advertising revenue will keep growing along with it.

But how are ad revenues related to Android?

Comparing Google's ad model with that of Facebook, the social network does not have an operating system of its own that it can piggyback on for user growth, unlike what Android does for Google. But what does Android actually do for Google?

When smartphone usage grows, the majority of that growth will naturally be in the mid to low-end price bands, which is ruled by Android. More Android users mean more potential users of Google Chrome and Google Search.

As long as Android remains the de facto mobile operating system for hundreds of millions of additional new users over the next 10 years, it will keep feeding traffic into Google Chrome, which is the gateway to one of the most lucrative ad networks in the world, if not the best.

That is Google's insurance against future disruption by anyone, including Facebook and the slowly emerging content and advertising juggernaut that is Verizon (VZ).

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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This article first appeared on GuruFocus.