Don't Sweat Alphabet's Brain Drain

By Markets Fool.com

In short succession these past few months, three of Alphabet's (NASDAQ: GOOG)(NASDAQ: GOOGL)executives -- Chris Urmson of the self-driving car project, Bill Maris of Google Ventures, and Tony Fadell of Nest Labs -- have left the company.

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On this episode ofIndustry Focus: Tech, analysts Dylan Lewis and Daniel Sparks take a look at what each of the executives did, their stated reasons for leaving (and some unstated factors that may have contributed), and how much these departures will affect the company's bottom line.

Also, the hosts talk about Alphabet's restructuring plans, and how the company's stock is looking for long-term investors.

A full transcript follows the video.

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This podcast was recorded on Aug. 12, 2016.

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Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, August 12th, and we're talking tech and the recent brain drain at Alphabet. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com senior technology specialist Daniel Sparks. Daniel, how is it going?

Daniel Sparks: Good, thanks for having me on the show!

Lewis: It's a pleasure. It's always a pleasure. Daniel, in the flurry of tech earning releases that we covered over the last couple of weeks, we had Netflix, we had Apple, we had Facebook (NASDAQ: FB). We glossed over what was going on over at Alphabet. Admittedly I was going to leave it that way, up until a couple of relatively high-profile departures from some of the subsidiaries within Alphabet. I think it warranted a check-in on what's going on with their business, and how things are looking over there.

Sparks: Yeah. Chris Urmson and then Bill Maris, yeah this will be interesting to discuss, both two important executives of the company.

Lewis: Yeah, earlier this week in a post on Medium, Chris Urmson, who is the director of Google's self driving car project, announced that he was leaving the project and the company. In that post he said, "After leading our cars through the human equivalent of a 150 years of driving and helping our project make the leap from pure research to developing a product that we hope someday anyone can be able to use, I'm ready for a fresh challenge." He went on to say, "If I can find another project that turns into an obsession and become something more, I will consider myself twice lucky." If you're interested in reading the whole post the title is, "The view from the front seat of the Google self driving car, a new chapter," that's over on Medium.

This was pretty surprising to me. This is someone that was involved in the self-driving car project pretty much from day 1 at Google. His prior research was in autonomous driving. He was in the early DARPA competitions for these, let's try to get something out there self-driving car projects that eventually materialized into what Google's working on now. That has kind of been his life for the last decade. He's basically running a team that he's been working with for a very long time there. I was shocked by this news.

Sparks: Yeah. You have to wonder if it has something to do with the balance that Google takes on with its self driving cars, between operating as, "Okay, this is the technology and we're going to stick with developing a technology and outsourcing it to other businesses," or if they're thinking more toward the line, maybe not talking about it publicly but doing something internally as a business with this technology. Maybe this has something to do with balancing between those lines, whether they're going to outsource the technology or do something internally. They recently transitioned to Alphabet, so yeah, it makes you wonder why he's leaving and what could have caused that.

Lewis: Yeah, and I think one of the interesting things here is, as much as I've been paying attention at least, pretty much everything I've heard about Google's self-driving car project has come from Urmson himself. He's been the one providing updates, he's been the one offering up the vision on what's going on there. I was at South by Southwest earlier this year and saw him speak, he was one of the keynotes. He talked about this idea of, "We want to create the tech that powers this and allows for these types of systems to be mainstream. We're not interested in manufacturing cars ourselves, we're going to partner up with some of the legacy auto manufacturers to make that happen."

That has been the company line for quite some time now. You see last year, the company hired John Krafcik, who is former president and CEO of Hyundai America,and they brought on to be the chief of the car project, so more of a business role, with Urmson leading the tech side of things. I think part of the plan there was to spin out this effort that they're working on in self-driving cars into some sort of stand-alone business, whether it's auto manufacturing, whether it's providing this tech, maybe licensing it out to the auto manufacturers. You wonder if that move might have caused some ripples within the development of the project, and might have caused Urmson to want to go elsewhere.

Sparks: Yeah, another area I speculate about Urmson is, this is a time where as the technology's developing and maturing, his confidence in the technology itself has grown. It makes you wonder if he's thinking, "Okay, this is a bigger deal than I thought," maybe he wants to go somewhere where someone's going to take him more seriously, but as we were talking, too, before the show, Google's definitely a leader in this space, so where else are you going to go? You hear Apple doing these things, maybe there. As this technology becomes safer, he's realizing this could save millions of lives in the future, and maybe he's rethinking now that he has a higher confidence -- maybe it's helping him think differently about the trajectory for where he wants to go in his career.

Lewis: Yeah, and he is not the only person to leave from the self-driving car project at Google. Earlier this year, a couple of employees, one of them Anthony Levandowski, who was an engineer on that project, and Lior Ron, who was involved in the Google Maps project, they both left to found a self-driving truck start up, Otto. You are seeing, it's natural for there to be talent leaving, it's just surprising when it's someone as high-profile as Chris Urmson. I think he's one of the most recognizable people in the self-driving auto space.

Sparks: Yeah, I definitely agree.

Lewis: I will say, to quell some of the speculation here, it's not totally unheard of. The person that originally headed the Google self-driving car project, Sebastian Thrun, he left in 2014, stepped down from his post and basically handed the keys to the castle over to Urmson. He went on to focus on Udacity, which is a vocational learning platform. Some of these guys, they just get tired of working on something and they want to chase something else. They get it to 85%, or something like that, and then they're ready to hand it off and face a new challenge. That might be the case here, but it seems bizarre to me given how focused Urmson has been, his entire public career at least, on this self-driving car technology.

Sparks: Yeah. You have to wonder if it's a loss for Google at this point. There have been some comments as major media outlets have interviewed some of his peers, saying it is a loss for Google. How Google is going to manage this from here is something we're going to have to see.

Lewis: Yeah, and Urmson is not the only exec to head out recently. To follow that, earlier this week, we found out Bill Maris, who is the founder and chief of Google Ventures, which is an early-stage investment arm of Alphabet, will be leaving the firm and its parent, Alphabet. This is a segment that Google, Alphabet, that we don't really discuss all that often, but to give you some context in terms of what they're working with, in 2015, they managed over 2.4 billion, and under Maris, the firm made early investments in the likes of Uber, jet.com, Nest, and Slack, just to name a few. This is clearly someone that was pretty influential in that part of their business.

As for reasons for why he left, in an interview with Recode, Maris said, "It's mission accomplished for me. Eight years is longer than I thought I would spend." On his end, it sounds like he had a defined time frame, he wants to spend time with his kids and his family, and there might be a new challenge out there, but I don't know that he's going to be going over to something competing, or that there was an issue of different vision there, at least in this case.

Sparks: Yeah, Bill Maris. Some other executives, Tony Fadell leaving, the Nest hardware engineer, I think that that is particularly interesting. Because he's had a history at Apple before he switches over to Google, and that was a big deal, bringing Nest, because that was, I guess, their foray into the Internet of Things area. To see him leave, among these other executives, it makes you really think about, "Hey, what's going on here with these executives leaving?" Especially, like we said, right after this Alphabet restructure.

Lewis: Yeah, and with Fadell, that was something that happened in early June, I believe.

Sparks: Mm-hmm.

Lewis: That followed what was a culture clash issue, might be the best way to describe it. There was, it seemed like, quite an issue, there. There was a very public feud with Greg Duffy, who is the CEO of Dropcam, which is a company that Nest acquired. You talked about this a little bit before, but Fadell has this Apple background, and it's this obsessive, all about the product, micro-managed, Steve Jobs-type of approach to things, and that is not really the Google way of doing things. I think it's a softer type of management style that most people expect at Google. I think that led to a lot of the problems that happened under Fadell's tenure.

You look at this, we have Urmson, we have Maris, and we have Fadell in a matter of a couple months. Those are big names in terms of leading these projects, but how do these projects fit into Google's financials overall? What does the other bets segment look like for them?

Sparks: This does bring us back to looking at Alphabet as a company. While they did restructure to emphasize these other areas that we're talking about right now so they could say, "Hey, we're an advertising business, but we also do these other things. We're going to give these areas some more transparency," but at the end of the day, Google is an advertising company. You look at their other bets segment, and that's where these things fall into. That's where Nest falls into, that's where Google Ventures falls into, and this is a very tiny segment as a portion of the company's total revenue.

The revenue in the company's most recent quarter, coming from other bets, was 185 million, and Alphabet's total revenue is over $20 billion. This, this is a very small segment. Then you look at the operating profits coming from the segment, well, it's not operating profits, it's actually a huge, giant loss, approaching $1 billion, actually, up from last year's loss in the segment. At the end of the day, these are really interesting segments, and they are part of Alphabet's strategy to focus on moonshots, but at the end of the day, these are segments that aren't material to investors to today, maybe as a whole they are, but individually, as each sub-segment within other bets, they're not materially impactful to the business.

Lewis: Yeah, and you touched on the transition from Google to the holding company, Alphabet, approach. I've seen some outlets try to tie some of these departures to that transition. I think it's worth touching on that as a topic. When we broke down Google restructuring, that was about a year ago, on Industry Focus, we hit on three major reasons for this move. One of them was autonomy, the idea of being with this new structure, Google can give operating division a little bit more leeway in making their own decisions, and that might allow some of those businesses to be a little bit more nimble. Another one was talent retention. The idea was that they can elevate high performers to executive level standing within these sub-companies.

The last one was transparency, and the idea that this holding company structure can give financial transparency. You break out the ad revenue side of their business from all these other bets, you get a little bit more insight on the investors' side as to what's going on, where money is going. Of course, with those benefits comes more focused financial scrutiny, and I think a little bit of an initiative to reining cost on some of these other bets. We've seen that come up a couple times in the conference calls lately. It's a tempting narrative to say that the structure change to this holding company might be causing some of these departures, but I think it's worth noting Google Ventures has been more or less operating independently for quite some time. They haven't really been tied into the ad side and the internet property side of the business operationally. They've been left to do their own thing.

I think the problems with Fadell and Nest are much more of a culture and management issue, and it was time for someone to leave there. The only one that I think that there might actually hold some water here for this argument is Urmson leaving. Really, that's because you look at the idea of giving these departments more autonomy and then them bringing in an executive from the auto industry, and that possibly being disruptive in what that division wants to accomplish. I've seen some reports that Urmson was not particularly thrilled with the direction that they were going with things and that he had let that be known to Larry Page. That might have bubbled up there, and that might have been causing issues, but I think broad stroke, it is not a problem of the holding company structure. I think it's more individual issues with each executive.

Sparks: Yeah, I think so. With Bill Maris, it was a very independently operated segment. He said that when he was leaving, and he did mention some other reasons for leaving, noting that even just to spend more time with his family, saying he didn't plan on staying there for eight years in the first place. Sometimes it's interesting to read into these things, but at the end of the day, we really never know.

Lewis: We talked about the impact that these segments have on Alphabet's overall numbers -- pretty small. I think it's worth talking about what actually happened in the most recent quarter with Alphabet, and really specifically the Google and internet property segment, do a run-down there since we underscored that that's really where the money is being made, and that's where investors should focus.

Sparks: Yeah. The most recent quarter they reported on July 28, so not too far away. Revenue for Alphabet was up 21%, 25% in constant currency. Obviously, Alphabet was the main driver, here, in the company's business. I had already mentioned that Alphabet's other bets segment actually reported an operating loss of nearly $900 million, approaching $1 billion there. It's interesting to highlight, the investors really like the report. Alphabet's core business pleased investors, which is advertising. The stock is up, it's up about 6% since they reported results, and up 24% in the past year. The stock is doing really well. The stock is trading at a P/E of 30 now, which is pretty pricey. I don't know, what do you think about that, Dylan? What do you think about investors as far as how they should approach thinking about selling the stock, or holding it as the stock trades higher?

Lewis: Yeah, that's always tempting once a company starts to hit a frothy valuation. I'll say though, you look at the double-digit growth that they're posting in constant currency, it's how it was stated, but in what is kind of legacy business for them, right? They've been running this ad business forever. That's impressive, there's still a pretty big runway there. I know my thesis for a long time with Alphabet has been, "Okay, the ad side of the business is just going to print money and fund pretty much everything they want to do. One of the other bets at some point is going to take off, become material to the business, and be a driver of top-line, and hopefully bottom-line growth. "

I kind of think about their other bets segment, the way that people invest in venture capital, where you take a lot of small calculated risks, and the idea of being one of them will really explode. That's kind of in my thesis in them, I don't have any intentions of selling any time soon. I think that it's worth paying a premium for a company that has a very solid business. They are a staple of most people's lives, and they have a great product. There are plenty of different growth avenues available to them.

Sparks: Yeah. It also highlights a general idea of, how should investors think about selling stocks when they have a good business in their portfolio that's performing well, but the valuation might get a little bit pricey. Generally, I think, it's my philosophy, and I think it's something we think here at the Fool is, as long as a business in your portfolio is doing well, I like to hold on to that company, keep it in my portfolio, and give it room to run. Like you said, there's these other bets that could pay off, and the reason you have confidence that they could pay off is because of Google's execution in the past. I think that I'd like to hold on to this company if I did own it. I don't but I made a Fool Caps pick on it a while back, and I've never thought about ending that pick just because the valuation is higher. It's a great company, performing well -- I definitely want to hold on to it.

Lewis: Broadly thinking about Google, here, and incorporating some of these departures in our line of thinking a little bit, I know my feeling at least is, I'm not super worried with Maris heading out. That seemed like there was a natural transition that was going to happen at some point, and that he had a set time frame on how long he wanted to be working at Google Ventures. Urmson is kind of curious to me, and I want to see what happens with the self-driving car project moving forward. That's the one that I'm going to check in the most on and want to be updated on.

As for Fadell, I think it might actually be a good thing that he's no longer running the show, just because it was such a dysfunctional environment for such a long time that with that out of the way, they might be able to focus a little bit more on business outcomes and have a more unified group there working on the Nest product. Like we said, not huge, huge contributors to what's going on in terms of Alphabet's financials yet, but definitely something worth watching, and I think that's how investors have to think about it.

Sparks: Yeah, makes sense to me.

Lewis: Anything else before I let you go, Daniel?

Sparks: I think that it's worth highlighting one other aspect in Google's most recent quarter was that mobile was a driver, but Google did bring up the fact that desktop still matters. I think that this is an interesting narrative, we see Facebook recently bringing this narrative back in saying, "Yeah, 84% of our revenue comes from mobile, but let's make sure we're still supporting our desktop business." They're saying, "Let's make ad blocking more difficult." That's another area that I like to remind investors that, keep checking in on the desktop side of Alphabet's business as well, because they need to make sure and balance these areas really well, especially as the catalyst of mobile begins to decelerate and desktop begins to moderate as a portion of revenue.

Lewis: Yeah, we did a show on ad blocking and its impact on Google's internet segment, I want to say about a year ago, but we might due for an update on that. The landscape has changed a little bit, some mobile browsers have allowed ad blockers, so I think that that is probably worth checking in on. That might be an episode to watch out for in the future, listeners.

Folks, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, shoot us an email at industryfocus@fool.com. You can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes or check the Fool's family of shows at fool.com/podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned. Don't buy or sell anything based solely on what you hear. For Daniel Sparks, I'm Dylan Lewis, thanks for listening, and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Daniel Sparks owns shares of Apple. Dylan Lewis owns shares of Alphabet (A shares) and Apple. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Apple, Facebook, and Netflix. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days.

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