Financial options are the right to buy or sell an underlying asset or instrument. You don’t value options based simply on their current income. You value them based on the underlying volatility of the risk you are trying to manage, relative to a risk-free rate of return. So the fact that Other Bets cost Alphabet $868 million last year says almost nothing about whether these options are going to be in the money or not. In a typical venture capital fund, for example, the first five years of the fund are spent investing in a portfolio of startups, and the last five years of the fund are spent trying to achieve liquidity events (“exits”) for each of those portfolio companies. After the first five years, the income statement of a venture fund would be highly negative, with a lot of investment made, and little revenue coming out. But there may be one or more great businesses in the portfolio that will emerge with a little more time. Indeed, Google Ventures and Capital G are both venture funds for Alphabet that are reported as part of these Other Bets.Īnd the operating businesses in Other Bets have had some events that show that some business value is indeed in the process of being created. Verily, a life sciences Other Bet, received a $1 billion investment last year from Silver Lake Partners, a savvy private equity investor. We don’t know the exact terms of this investment, but with some simple assumptions, we can show why this might be a valuable option for Alphabet to have. Assume that Silver Lake got half of the venture for its $1 billion investment. Assume that Silver Lake strives for a 10x return within 10 years in making this investment. That suggests that Silver Lake expects its investment to be worth $10 billion, making Alphabet’s remaining stake also worth $10 billion. Over ten years, Alphabet’s stake would be worth $1 billion per year, more than covering the total loss for Alphabet on all of the Other Bets, if this option ends up in the money.Options are a right, but not an obligation, to undertake some kind of business or financing activity. I worry that the market has it wrong, or more precisely, I worry that the market is being too myopic in its assessment of Alphabet, particularly its Other Bets. At the most basic level, some analysts appear to assume that all of the money being spent in Other Bets is simply wasted, that nothing of value is being created. (Alphabet reported that its Other Bets lost $868 million in FY 2018, on revenues of $595 million). At another level, the many activities going on in Other Bets, from Calico, DeepMind, GV, CapitalG, X, Google Fiber, Jigsaw, Makani, Sidewalk Labs, Verily, Waymo, Wing and Loon operate in wildly different businesses, and many analysts appear to simply ignore whatever business success they are having. This is deeply anti-innovative thinking.Ī better way to think of these Other Bets is as Real Options. An option is the right, but not the requirement, to take an action at a later time. So you can buy an option on oil for $100 a barrel. If the price of oil jumps up above $100 a barrel, this option is “in the money”, and becomes valuable. If oil prices remain where they are today, the option is “out of the money”, and worth nothing. Options are great tools for managing risk (in this case, the risk that oil prices spike). They don’t cost much to create, and some of the time they become worthless. But other times, they can create a lot of value.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |