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Standard & Poor's


10/27/14 10:35:53 AM



This week's Focus Stock of the Week is Google (GOOGL $549.72), which carries S&P Capital IQ's

highest investment recommendation of 5-STARS, or Strong Buy. We upgraded our opinion on GOOGL, which is the ticker for the Class A shares of the company, after the company reported third-quarter results earlier this month, and following notable year-to-date underperformance (as detailed below).

We see leading franchises, healthy growth, benefits from the pending sale of the Motorola smartphone and tablet unit, a strong and flexible balance sheet, and a compelling valuation.

GOOGL is a global technology company whose stated mission is to organize the world's information and make it universally accessible and useful. GOOGL has amassed and maintains what we believe is the Internet's largest index of information, and makes most of it freely accessible and usable to anyone with online access. GOOGL's websites are a leading Internet destination, and its brand is one of the most recognized in the world. International sources accounted for 58% of third quarter revenues.

The company's advertising program, called AdWords, enables advertisers to present online ads when users are

searching for related information. Advertisers employ GOOGL's tools to create text-based ads, bid on keywords

that trigger display of their ads, and set daily spending budgets. Ads are ranked for presentation

based on the maximum cost per click set by the advertiser, click-through rates, and other factors used to

determine ad relevance. This process is designed to favor the most relevant ads. GOOGL's AdSense technology

enables its network affiliates to provide targeted ads from AdWords advertisers.

The word Google has become synonymous with the Internet search category. We believe this reflects GOOGL's historically strong focus on the search segment, and the company's related market share leadership in many countries around the world, including the U.S.

Google has expanded its efforts beyond the traditional online search category. The company has announced or introduced an e-mail service (Gmail), mapping offerings (Google Maps), an instant messaging service (Google Talk), a finance offering (Google Finance), a mobile Internet software platform (Android), an Internet browser (Google Chrome), a social network (Google+), computer tablets (under the Nexus brand), and wearable technology (Google Glass).We believe these initiatives and others have been intended to broaden GOOGL's reach, and to increasingly attract users and spur activity and engagement. The company has been discontinuing investment in and operations of offerings that have not gained sufficient traction. We have noted more recent investment and acquisition activity related to robotics and the "Internet of Things."

We believe revenues will rise 11% in 2014 and 18% in 2015. In April 2013, GOOGL sold Motorola's Home unit to Arris (ARRS 25 ****), in a deal valued at $2.4 billion in cash and stock. In January 2014, GOOGL announced the proposed sale of the remainder of Motorola for some $2.9 billion. We see growth in the Google segment notably exceeding that of the company in 2014, owing to growth in online advertising and increasing traction for GOOGL's display offerings. We forecast non-GAAP EPS of $26.05 for 2014, $30.92 for 2015, and $36.23 for 2016, following $19.94 in 2012 and $21.95 in 2013.

In January 2014, GOOGL announced plans to sell Motorola to Chinese hardware company Lenovo, in a transaction valued at $2.9 billion. We see potential regulatory challenges to consummating the deal, but believe it would be positive for GOOGL. Nonetheless, we see healthy growth from the namesake business unit, with opportunities related to mobile, video, and international. Concerns related to mobile advertising pricing persist, but have moderated somewhat, in our opinion.

Meanwhile, year to date through October 24, GOOGL declined 7.1%, while the S&P 500 rose 12%, the S&P 500 Technology Sector index rose 21%, and the S&P 500 Internet Software & Services sub-industry index increased 18%.

Our 12-month target price of $650 reflects our DCF analysis. Our model assumes a WACC of 8.6%, five-year average annual FCF growth of 15%, and a perpetuity growth rate of 3%. Motorola has restrained FCF growth, reflecting a less profitable business model and the need for greater investment.

As of September 2014, the company had $58 billion in cash and short-term investments and $8.6 billion in debt.

Risks to our recommendation and target price include the potential for challenges in selling Motorola, market share losses, excess expenditures associated with expansion, and adverse legal/regulatory developments.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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