Alphabet (GOOG/GOOGL) reported slightly disappointing 4Q19 results compared to elevated expectations that existed thanks to a +10% gain in the shares in January to all-time highs.  Looking more closely at the quarter, the headline miss in revenues was heavily concentrated in hardware sales, an area where Northlake has little concern.  Overall advertising revenues at search and YouTube were a touch light but nothing to worry about.  Facebook also fell a little short on advertising revenues in 4Q.  Both companies noted a slowdown in U.S. growth, which likely was caused by the shorter holiday selling season in 2020 vs. 2019, 22 days vs 27 days.  Alphabet still enjoyed +19% currency adjusted growth in search and newly disclosed YouTube revenues grew 26%.  While traders will quibble about 19% growth vs. expectations for 20% or YouTube absolute revenue dollars being a little smaller than expected, Northlake finds these growth rates to be very impressive.  In addition, newly disclosed information about Google Cloud reveals a $10B annual revenue rate growing at 53%.  The core part of cloud is growing even faster and management revealed a large number of $50 million and above cloud contracts, a good sign that that Google Cloud is competing well against Amazon and Microsoft.

The new disclosures breaking out revenue are a significant positive as YouTube and Google Cloud are deserving of premium valuations that we believe are not fully reflected in GOOG/GOOGL share prices.  Prior to this report, investors were left to guess and much was made of Alphabet’s limited disclosure as a headwind to higher valuation for GOOG/GOOGL.

Management was also was more forthcoming with comments about revenue guidance and capital allocation.  While no specific revenue guidance was provided, when discussing the new reporting segments, management used adjectives like “ample” and “substantial” and “enormous.”  We take these word choices as indicating that management sees no material slowing in overall revenue growth beyond the normal fluctuations that occur from quarter to quarter.

There were two important new positives related to capital allocation disclosure.  First, management gave specific guidance as the pace of the share buyback and the level will be higher and more consistent than expected during 2020.  The current authorization should be completely used by the end of 2020 setting up another large buyback as a positive catalyst later this year.  Second, regarding Other Bets, comments were offered that Verily (health care) had brought in outside investors and similar actions were being sought for more Other Bets.  Management described these actions as designed to both realize value for these investments and to help fund their future growth.

We believe the added disclosure across many areas is a significant tell for an expanded valuation for Alphabet shares coming in the first quarter after the company elevated a non-founder to the role of CEO.  Alphabet’s valuation on Northlake’s preferred Enterprise Value to EBITDA basis sits below the average stock in the S&P 500 despite the company’s sustained growth rate near 20% and many money-losing or low margin businesses that are surely worth tens of billions in market capitalization based on comparable stocks.  Added disclosure should help investors better understand the long-term growth drivers at Alphabet and result in a higher valuation for GOOG/GOOGL.  Using a conservative multiple of 12.5X vs. the S&P 500 average of 11X and giving just $80 billion in value for Other Bets, Google Cloud, and YouTube, we can see the shares reaching $1,525 over the next few quarters.  Looking further out to 2021, we can see GOOG/GOOGL rising to over $1,700.  Alphabet shares remain a core holding for Northlake.

GOOG/GOOGL is 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/GOOGL is a net long position 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.