Alphabet (GOOG/GOOGL) reported a good quarter relative to expectations but saw more mixed fundamental trends than the other tech giants including its closest peer, Facebook.  There was nothing wrong with GOOG’s quarter but it paled in comparison to blowouts reported by Amazon, Apple, and Facebook and this led to a modest sell off of about 3% in GOOG/GOOGL shares on the day following the earnings report.

Facebook reported positive revenue growth and an exit growth rate of 10% for the quarter.  Google Search had -10% growth and exited the quarter at flat year-over-year growth.  Search is Alphabet’s largest business by far.  The second largest business is YouTube which enjoyed 6% revenue growth although this was a slower level than the upper-single-digit growth back in March and April.  Search and YouTube are much more exposed to brand advertising than direct response advertising.  Equally important, travel and tourism may be as much as 15% of Search and remains at a minimal activity level with air travel still down 80% in many regions of the world and hotel occupancy between 30% and 40% in major global urban centers.

Overall, Alphabet managed flat revenues adjusted for foreign exchange thanks to continued growth of over 40% at Google Cloud and 26% growth for Other businesses driven by the Google Play Store (the equivalent of Apple’s App Store for Android devices) and YouTube subscription businesses.

Alphabet has been doing a better job on cost controls over the past year and operating margins are under less pressure than Facebook or Amazon, other companies that are continuing to invest aggressively right through the recession.  One reason these stocks have done so well is the willingness to invest to sustain superior revenue growth against large and still growing total addressable markets.  Search is perhaps more mature than social media or e-commerce or streaming video but Google continues to develop its shopping/e-commerce business.  Furthermore, general growth in digital business and commerce largely begins with search where Google’s position is dominant.

Alphabet has enjoyed modestly decelerating revenue growth over the last few years as Search has matured but prior to the pandemic was still growing in upper teens.  As Cloud continues to grow rapidly and when brand advertising and travel and tourism return, Northlake believes Alphabet can return to pre-pandemic growth. Improved cost controls, more disclosure on operations, and a big boost to shareholder friendly actions such as the new $28 billion buyback announced in conjunction with second quarter earnings are also positives.  At 13X 2021 EBITDA giving no credit non-EBITDA producing assets including Google Cloud, Self-driving leader Waymo, and health care company Verily, we find Alphabet shares attractive as a core holding.  We think the shares can trade at 15X EBITDA.  Adding conservative values on Cloud, Waymo, and Verily, we can get to a target of $1,650 to $1,700 looking out to the end of 2020, unchanged from our view after our last update in April.

We do expect the government to take regulatory action against Alphabet within the next few months.  We believe this is widely anticipated and thus at least partially reflected in the current stock price.  Given the deep discount at which Alphabet shares trade on a sum of the parts basis, we see downside supported even with aggressive regulatory actions.

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.