Media Talk

Disciplined Growth Continues at Alphabet

Alphabet (GOOGL) reported good fourth quarter and full year results to close out 2016. GOOGL beat sales estimates, but missed EPS targets due to a one-time equipment write-off and a higher than expected tax rate. The core Search business continued to perform well, with paid clicks growing 36% year-over-year compared to estimates of 27% growth. The strong ad volume growth was offset by costs per click falling 15% year-over-year, worse than the estimated 11% decline. Like Facebook (FB), GOOGL has masterfully maneuvered the shift from desktop to mobile.

GOOGL’s critical verticals such as YouTube, Google Cloud Platform and G Suite, AI and machine learning initiatives, new Pixel and Home hardware, and updated operating system software for Android, Chrome, and Daydream VR all appear on track to deliver continued growth with disciplined investment. Meanwhile, “other bets” such as Fiber, Nest, Calico, Verily, and Google Ventures are being prudently managed to provide unrivaled optionality while minimizing the negative impact to current operating results.

The recent launch of YouTube Red, a subscription video service, compliments YouTube Music and the Google Play store by offering ad-free premium content. GOOGL hinted at plans to expand their premium content offerings while simultaneously streamlining or consolidating their media products over the next year. GOOGL believes that both Google Cloud Platform and G Suite now offer differentiated cloud services compared to competitors like Microsoft (MSFT) and Amazon (AMZN), allowing the company to focus on growing sales in areas that benefit from that new expertise. AI and machine learning initiatives drive GOOGL’s product and service ecosystem, allowing the company to quickly iterate developments that improve the consistency of the user experience whether typing a search on a Chromebook or using voice search via Google Assistant on a new Pixel phone, Google Home, or Android-connected car.

In summary, GOOGL remains on track to deliver outstanding sales and profit growth for the foreseeable future driven by the core Search business and critical verticals of YouTube, Cloud, AI, hardware, and software. The ongoing secular shift from traditional to digital advertising should continue to be a long-term tailwind. Further optionality is provided by disciplined investments in “other bets.” We expect over 16% upside at GOOGL with an increased target price of $952 based on 23x 2017 EPS of $41.39.

GOOG and GOOGL are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  GOOG and GOOGL are net long positions in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

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