The Meaning of the Google Layoffs

The repricing of revenue.

Jan 27, 2023

Cash-Rich But Cutting Headcount

Earlier this week, we looked at a couple of TikTok videos from a former Google employee in Los Angeles, a day in her life at the company,

And the day she got laid off.

She was one of twelve thousand Googlers laid off last week, a number which apparently included 31 massage therapists.

A question some investors have asked is why cash-rich, profitable companies like Google's parent Alphabet, Inc. (GOOG, GOOGL) would be cutting headcount. The short answer is that the market is repricing tech industry revenue, as this Leuthold Group chart illustrates.

The Repricing of Revenue

Matt Slotnick elaborated on this phenomenon in lucid Twitter thread this week:

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

seeing a lot of confusion around why layoffs are happening at companies with a lot of cash on the balance sheet. at the risk of getting roasted... here's a TLDR, for both public and private companies

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

in 2020 and 2021 the way to create shareholder value was to grow topline. regardless of the quality of revenue, software revenue was being valued at between 30x-100x run rate

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

smart investors know that not all revenue is equal... and they know that very few software businesses actually have the characteristics to drive meaningful cash flow at scale

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

because meaningful cash flow at scale requires a high margin product, high retention, and an ability to upsell and cross sell to drive increasing LTV. once you land, you need to expand share of wallet, continuously. for decades

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

many software categories fundamentally cannot ever support a company with these characteristics. history tells you this... but we forget!

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

so people put a lot of money into companies that were growing like this…

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

with the expectation that if you just grew topline fast enough, it would inevitably become this…

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

when in reality a lot of these business are destined to look like this

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

so now that the illusion of the inevitability of cash flows at scale is shattered, investors are looking for proof of operating leverage sooner

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

which is why layoffs are happening, regardless of the amount of cash on the balance sheet. management needs to prove that adding incremental spend drives marginally more return. it’s a reset on what it means to be a steward of investor capital

A commenter reading this thread assumed this logic wouldn't apply to big cap tech companies such as Google and Microsoft, Inc. (MSFT), but Slotnick pointed out size offers no escape here:

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

@amyhoy disagree! when a dollar of incremental revenue is valued abnormally high, companies are incentivize to add costs even if they’re inefficiently productive at any stage, investors are investing in future cash flows

Matt Slotnick (traveling CRM salesman, in nyc) @matt_slotnick

@amyhoy if yesterday a dollar of revenue is valued at 20x, the return hurdle for incremental spend is low when it goes to 10x, the hurdle is relatively higher, and you now have an inefficient cost structure

Google And The Next Big Thing

Aside from the repricing of revenue, another caution flag for Google is that it no longer appears to be at the cutting edge of technology. Its dominance in search has led to an explosion in SEO (search engine optimization), which is why you can't Google a recipe without getting a keyword-stuffed essay as a preamble to it. Silicon Valley chatter suggests that enormous advances in artificial intelligence are happening now, and apparently Google is lobbying to shut it down.

Balaji @balajis

Hearing rumors that Google is lobbying DC to shut down other AI efforts, by scaremongering about how unsafe they are.

Balaji @balajis

What a reversal from 2003. Microsoft is becoming Google by out-innovating on search. Is Google becoming Microsoft by FUDing the competition they can’t beat?

Investing Implications

Occasionally, my personal view of securities and the Portfolio Armor system's take on them diverge, but on Google, we're both aligned. Portfolio Armor currently estimates Google will have a positive, but below-market return over the next several months. To me, it doesn't seem like a good long or short candidate; it seems to be in a grey zone where it has become less attractive to growth investors but not cheap enough to entice value investors. I prefer to bet against companies that aren't profitable and cash rich. Speaking of which, let's close with an update one: Bed Bath & Beyond (BBBY).