Maybe Alphabet Inc. (Nasdaq: GOOGL) should have named its new smartphone the “Trojan Horse.”
See, there’s a lot more going on here than the introduction of a new piece of hardware.
Now, don’t get me wrong. The Pixel 2 is an impressive device.
And on the surface, it seems designed to compete head-on with the iPhone from Apple Inc. (Nasdaq: AAPL). After all, it sports a state-of-the-art organic light-emitting diode (OLED) and comes in standard and plus sizes.
The Pixel 2 debuted two weeks ago along with several other pieces of hardware, including an updated laptop and an artificial intelligence-powered wearable camera. And the global leader in online search got generally great reviews for its new products.
However, I have to say the real star of the show received almost no attention.
It’s the hidden ingredient that is the true driving force behind these moves.
Will it help Alphabet’s stock over the long run?
Here’s what I think.
Despite Some Hardware Plays, It’s All About the Software
I recently appeared as a guest on CNBC World to discuss Alphabet’s moves. At the time, I said the new phone wouldn’t “move the needle” all that much for the stock.
Fact is, it’s a software play by Alphabet that makes all of this so intriguing. And that software – which I’ll tell you about momentarily – is what’s going to help the company’s growth and profit margins in the months ahead.
Yes, I recognize that the firm unveiled the Pixel on the heels of its recent investment of $1.1 billion in Taiwanese smartphone manufacturer HTC Corp.
Under terms of the HTC deal, Alphabet is going to transfer 2,000 workers to its own R&D unit. That tells me the firm has hardware ambitions beyond the phone.
But here’s why I say the Pixel is Alphabet’s “Trojan Horse.” The company is taking a page out of Apple’s playbook and making the Pixel the central piece in its hub-and-spoke software strategy.
It’s a great new sales hook…
Taking a Page from Apple’s Book
When it comes to quality and profit margins, Apple dominates with its iPhone. But the iPhone commands that level of respect in no small measure because it’s central to Apple’s far-flung hardware empire – and its app, music, and movie sales.
What Apple has built is nothing short of the best consumer-centric tech ecosystem in the world today. And it all starts with the iPhone, which accounts for more than two-thirds of Apple’s sales.
With the iPhone, users can “talk” to all their devices basically at the same time. For instance, if you update your calendar on your phone, that update automatically shows up on your MacBook and iPad.
If my iPhone rings, so does my iPad and Apple Watch. And it all works backward as well. When I update my MacBook, I’m updating my phone right along with it.
To get to that level of seamless integration, Alphabet must have its own branded handset.
So, investing heavily in the development team at HTC and the Pixel allows Alphabet to come up with an enhanced version of its Android operating system, the most widely used in the world.
Doing so also allows Alphabet to market its own phone in a way that won’t anger its partners who rely on Android. I’m talking here, of course, about Samsung Electronics Co. Ltd. (OTCMKTS: SSNLF), the world leader in Android smartphones.
Those software upgrades will allow the Pixel to play a more vital role than the sales figure would indicate. ComScore says only an average 0.7% of U.S. smartphone subscribers used the Pixel in the three-month period ending in August, the last month for full data.
To put that into perspective, 45% of subscribers used Apple’s iPhone, and 29.5% used a Samsung.
However, if you look at it another way, well over half of American smartphone users carry an Android (Alphabet) phone.
In other words, the Pixel 2 has some built-in advantages that can add to Alphabet’s bottom line.
And to Alphabet investors’ bottom line…
Even Moderate Success Means Major Profit
Let’s say the Pixel captures just 5% of the global market for smartphones. That would give it sales of 75 million units a year. And at a conservative $650 average selling price, we’re talking $48 billion in new yearly sales.
Even better for Alphabet is how that advance will spark interest in other parts of its tech “ecosystem.”
For instance, the company has its Nest thermostat, the Chromebook laptop, the OnHub Wi-Fi router, and the Chromecast web streaming box. It also has an AI-driven Google Home smart speaker. Google Assistant is the company’s version of Apple’s Siri – and it will integrate to the Home and Pixel.
There’s another aspect of the Pixel’s emerging role that no one on Wall Street or the media even mentioned. The device fits nicely into Alphabet’s vision of a wireless world…
Google’s Ecosystem Starts in Space
Back in 2015, the firm joined with Fidelity Investments in a $1 billion investment in Elon Musk’s Space Exploration Technologies Corp.
That means Alphabet owns about 10% of SpaceX – and it advances the Silicon Valley giant’s bid to use satellites to provide wireless web access.
Google is doing so because more than two-thirds of the world’s 7 billion people lack Internet.
By backing SpaceX, Google hopes to be able to launch a new generation of small satellites that will beam web signals to remote regions of the world.
And when that effort comes to fruition, Google will have its Pixel ready. It’s a robust smartphone that allows all of these billions of new users to connect to its far-flung Wi-Fi system.
At that point, the mobile advertising juggernaut and world leader in online search will have a truly global tech ecosystem. All its branded products will give users a truly unified system.
With a market cap of $686.10 billion, the stock trades at roughly $1,001 a share – and still has plenty of upside ahead.
Over the past three years, the company has grown sales by an average 18%. If all it did was keep that same rate, earnings per share will have doubled in exactly four years.
That doesn’t even take into account that the new Pixel 2 could add several billion dollars in profits some three years out.
Add it all up and you can see that Google’s new “Trojan Horse” – I mean, Pixel 2 – could have a solid, long-term effect on the stock.
That’s what everyone missed a couple of weeks ago. But not us.
*This has been a guest post by Money Morning*