ALPHABET, INC. (NASDAQ: GOOGL) · Share Highlights Market Capitalization $510.77B . Shares...

Important disclosures appear on the last page of this report 1

Analysts Adam Dellos [email protected]

Anthony Yang [email protected]

Company Overview Alphabet, Inc. is a global conglomerate and leader in the technology sector. Its business has two primary segments: Google and Other Bets. The Google segment contains Alphabet’s core products, such as Search, Maps, YouTube, and Gmail. Other Bets contains all non-material businesses, such as Google Fiber, Nest, and Verily. Alphabet mainly generates revenue from two different types of advertising: performance advertising, a click-based service, and brand advertising, a placement-based offering. Alphabet seeks to expand its presence in the technology sector by capitalizing on increasing internet availability in emerging markets and pursuing intense research and development endeavors in its Other Bets segment. Stock Performance Highlights 52 week High $839.00 52 week Low $672.66 Beta Value 1.063 Average Daily Volume 1.651M Share Highlights Market Capitalization $510.77B Shares Outstanding $294.84B Book Value per share $194.60 EPS (TTM) $2.11 P/E Ratio 12.06 Dividend Yield 3.35% Dividend Payout Ratio 44.55% Company Performance Highlights ROA 9.23% ROE 15.23% Sales $85.54B Growth in Paid Clicks 22.00% Key Financial Ratios Current Ratio 6.88 Debt to Equity 2.94

Current Price: $772.35

Target Price Range: $900.00 - $950.00 Key Investment Highlights • Capitalization of Increased Mobile Activity: The

consumer shift from desktop to mobile devices is a strong opportunity for the search engine industry because mobile activity has driven increased consumer interaction with digital media. Alphabet has positioned itself to expand and operate efficiently on mobile through its initiative to catalogue and optimize mobile web pages and advertisements. Our group believes that Alphabet will continue to realize returns from this investment as consumers continue to use mobile devices.

• Recession-Proof Revenues: Search engines are typically a cost-effective form of advertising; consequently, there is generally low volatility in revenues. Additionally, search engines allow marketers to directly interact with consumers, an opportunity companies are unwilling to give up even during challenging economic periods.

• Consistent Growth Prospects: Internet activity worldwide continues to grow as internet penetration increases and users spend more time on mobile devices. Our group predicts this growth in end users will continue to drive Alphabet’s high revenue growth.

• Inexpensive Price from Investor Uncertainty: Investors harbor strong uncertainty for the future of the technology industry after the recent presidential election, which has been reflected in up to 5% declines in many major technology stocks. Given the lack of evidence for upcoming material change, our group is confident in our valuation and considers the depressed price as further support for our buy recommendation.

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KRAUSE FUND RESEARCH FALL 2016

ALPHABET, INC. (NASDAQ: GOOGL)

Recommendation: BUY

NOVEMBER 15, 2016 Technology


Our team is issuing a BUY rating for Alphabet because we believe the company will maintain its high growth. We predict increases in internet penetration and mobile activity will continue to drive paid clicks for the search engine. Furthermore, revenues from Google’s search engine are likely to be shielded from negative effects of the business cycle given the nature of the search industry. In our valuation, we incorporated these trends into revenue growth and other key assumptions. Our valuation models yield a target price range of $900 - $950. Due to Alphabet’s historical lack of dividends and directly comparable firms, our group believes that the discounted cash flow and economic profit models have the most credibility. Given its currently depressed price, Alphabet is an especially attractive investment.

Gross Domestic Product Real Gross Domestic Product (Real GDP) is a measure of the value of goods and services produced in a country after adjusting for inflation. Real GDP provides insight to economic production and growth; consequently, it is a strong indicator of the health of an economy. Additionally, GDP and corporate profits in the technology sector have historically followed similar trajectories. Although the economy has continued to expand since the financial crisis, Real GDP growth has slowed. Between 1990-2008, Real GDP grew at an average annual rate of approximately 3%. In comparison, annual growth since 2008 has remained between 1.5-2.5% despite quantitative easing and other expansionary monetary policies.(2)

Source: U.S. Bureau of Economic Analysis(2) We predict Real GDP growth to be 2.0% in 2016 but lower to 1.5-2.0% in future years. While the markets have recovered since the financial crisis—as evidenced by the S&P record closing on November 9th—we are hesitant to expect significant economic growth given risks associated with the threat of rising interest rates and political uncertainty following the U.S. presidential election

Employment The unemployment rate reflects the percentage of the labor market that is actively searching for work but is currently not employed. This metric is a relevant economic indicator for Alphabet because of its impact on labor costs. As workers become scarce, companies are often forced to raise wages or increase spending on attracting qualified candidates. The national unemployment rate has continued to decrease from its peak at 10.2% in October 2009(3). The economy is currently near full-employment levels as the unemployment rate remains around 5.0%. With our team’s 2016 Real GDP forecast at 2.0%, we anticipate no significant upward movement in the unemployment rate in the short term. However, given the trend of slowing GDP growth and risk of future wage pressures, we anticipate the unemployment rate to increase to 5.25-6.00% in the long term.

Source: U.S. Bureau of Labor Statistics(3)

Within the technology sector, competition for labor is especially high due to concentration of companies headquartered in select geographic areas. As a result, the technology sector is susceptible to unemployment in these specific regions. For example, many technology companies are located in Santa Clara County, which has an unemployment rate of 3.8%.(4) The competition for labor in the area has resulted in increases in wages, as evidenced by median pay for early career employees exceeding $100,000 at industry leaders like Google, Facebook, and Microsoft.(5) Our team predicts an increase of the unemployment rate in these specific regions to 4.8 – 5.8% as a result of national trends and the continuation of elevated wage levels. Exchange Rates Alphabet generates a significant portion of its revenues overseas—consequently, it faces exposure to fluctuations in currency exchanges when reporting its financial performance in U.S. dollars. Although Alphabet hedges its international currency risk, the company is still vulnerable to large discrepancies in currencies and the effects of an appreciating U.S. dollar. Since 2014, the U.S. dollar has appreciated more than 18% due to relatively slow growth in the global economy compared to the United States. The U.S. Dollar Index (DXY) is currently trading at 99.80 and has remained stable over the past year.(6) Our team predicts the DXY to continue trading in the range of 93 to 100 for the next several months due to continued

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EXECUTIVE SUMMARY


weakness in foreign economies relative to the United States and uncertainty following political trade deals. The Euro-U.S. dollar and Pound-U.S. dollar exchanges are especially important to Alphabet, as the company generates significant revenues in the Europe. From 2013-2016, 10% of Google’s annual revenue came solely from the United Kingdom.(7) Consequently, changes in the purchasing power of the euro and pound pose significant foreign exchange risks to Alphabet. Over the past two years, there has been appreciation in the dollar against these currencies due to quantitative easing measures by the European Central Bank and effects of the Brexit. Since 2014, the Euro-U.S. dollar exchange rate has dropped from near $1.40 to almost $1.(8) Like other technology companies, Alphabet’s earnings have been negatively impacted by this currency change as it converts foreign earnings to U.S. dollars.

Source: XE.com(8)

India As internet penetration continues in India, technology companies are gaining access to potentially billions of consumers. Furthermore, growth is expected to be sustained—despite recent influxes of internet users, internet penetration in India is still only 30%.(9) The primary driver behind the increase in internet users has been a boom in smartphone ownership. Over the past year, India added 118 million new mobile-data users.(10) As smartphones become more popular, key players within the mobile hardware industry have made large ventures to expand sales in the region. Google now sells its Pixel to these end users and Apple plans to open brick-and-mortar stores within the next year.(11) Thus, smartphones are now widely available to end users and the internet is becoming more intertwined with Indian communities.

Source: Statista(12)

We predict internet penetration in India to grow as smartphone ownership increases, which our team expects to follow changes in consumer spending and Real GDP. Consumption in India has grown consistently year-to-year. Aside from brief downturns in 2008 and 2012, India’s economy has expanded at world-leading rates. We expect this trend to continue as further internet penetration will contribute to development of new industries and jobs in India’s economy. China Although Alphabet does not generate a significant portion of its revenues in China, the Chinese economy still influences the company’s financial performance. China’s recent downturn has contributed to the appreciation of the U.S. dollar and, consequently, reduced corporate profits for exporting-focused companies. The development of Chinese technology corporations also poses a threat to U.S. companies, specifically within the technology sector. Chinese companies now directly compete with their American counterparts through innovation. China is the second largest investor in research and development and saw an 8.4% increase in R&D spending going into 2015.(13) Furthermore, governmental policies have strengthened intellectual property law in China. While this protection benefits U.S.-based companies in the space, it is also allows multi-national Chinese corporations, such as Huwaei, to compete globally with fewer fees and less litigation.(14) As Alphabet continues to expand its product lines and enter new industries, our team predicts competition with Chinese corporations will increase. Europe Europe’s economy and political environment will continue to influence the U.S. macroeconomic environment. While the European economy has recovered since 2008, uncertainty still exists in the markets, specifically within the banking sector. Our team predicts uncertainty to continue as the region confronts consequences of the Brexit. We expect this doubt to be reflected as increased foreign exchange risk for multi-national companies. European politics may also influence U.S. markets and, more specifically, the technology sector. Recently, European courts


have pursued American-based, multi-national companies on anti-trust and tax evasion charges. Companies within the technology sector—such as Alphabet, Amazon, and Facebook—are likely to face to fines for their corporate tax structures and scaling practices. Given Apple’s $14.5 billion tax fine from the European Union,(15) our team believes the upcoming litigation will result in material changes and potentially hinder future financial performance for these industry leaders. Capital Markets Overview The U.S. technology sector is still an appealing area for investors. Although the technology sector experienced a slow summer in 2016, business activity has accelerated in the last two quarters of the year, specifically within the mergers and acquisitions space. In general, technology companies have historically outperformed the Dow and S&P 500 and are currently on pace to stay on-trend through 2016. Overall, the technology industry has largely been unaffected by the decline in global demand for smartphones. Instead, industry leaders have found new growth opportunities in cloud-focused software and storage industries. Our team predicts sustainable growth in these industries as end users become more familiar with cloud products and companies process more mass data. Following the U.S. presidential election, many leading technology stocks suffered declines of up to 5% due to consumer uncertainty about the implications to the technology sector.(16) However, due to the lack of evidence of any upcoming material impacts, our group is confident in our current valuation and expects that the relatively depressed price will yield strong return opportunities.

Industry Overview The search industry is comprised of companies that offer search engines or other search-based operations. Large search engines (e.g. Google, Baidu) have large market capitalizations; however, new competitors continue to enter the space. Companies in the search industry generate revenue primarily through advertising. The two most common products are paid placement and paid inclusion advertisements. In general, advertising revenue is driven by clicks on provided links. Data collected by companies in the search industry also serves as a valuable asset because it can be sold as proprietary information to institutions.(7)

Business Segments Search Engines In the United States and Europe, Google dominates the search industry. Google is the clear industry leader, as evidenced by its 67.3% market capitalization in the United States. Other competitors—such as Yahoo and Bing (18.2% and 10.8% market capitalizations, respectively)—have struggled to

compete with Google and maintain profitability.(17) Overall, U.S. consumers are accustomed to Google’s search capabilities, and our team expects the company to keep its position in the search industry in domestic markets for the foreseeable future.

Source: ComScore US Search Engine Market Share Report(17)

While Google is the most popular search company worldwide, foreign search engines, such as Baidu and Naver, have developed dominance in their respective regions. These companies originally focused on domestic consumers, however, they are now becoming international players. Baidu has expanded into Brazil, Egypt, India, Indonesia, Japan, and Thailand.(18) Google still remains the dominant search engine in these markets, but competition with Baidu may prove to be costly. Indirect Competitors Companies in the search industry also compete indirectly with major internet companies when users bypass search engines to find information from a specific source. For example, 44% of consumers start product searches on Amazon instead of search engines (33%) and retailers (21%).(18) Consequently, search companies are missing opportunities for online advertising and revenue. While there are few internet companies that dominate search inquiries in their industries—such Amazon and LinkedIn for retail and professional searches, respectively—Alphabet should be cognizant of these effects of changes in consumer behavior. These internet companies are unlikely to displace Google, but the decrease in searches will cut into the growth of paid clicks. Revenue Streams Revenues in the search industry are stable. Search engines are typically a cost-effective form of advertising; consequently, there is generally low volatility. Additionally, search engines allow marketers to directly interact with consumers, an opportunity companies are unwilling to give up even during challenging economic periods. Advertising revenues are primarily driven by two factors—the number of paid clicks and cost-per-click rates.

U.S. Market Share

INDUSTRY ANALYSIS


Number of Paid Clicks Paid clicks are defined as clicks by internet users on sponsored search listings. Companies within the search industry focus on this metric because advertisers typically pay on a “per-click basis.” Thus, growth in the aggregate paid clicks correlates directly with advertising revenues. Aggregate paid click growth has recently been driven by the increase in mobile search. Our team expects consumers to continue using mobile devices at increasing rates as companies further develop their mobile platforms. In return, aggregate paid click growth should increase as well.

Source: eMarketer(19)

Cost-Per-Click Rates The cost-per-click rate (CPC) is the price for advertising through companies in the search industry. CPC is influenced by many factors including the macroeconomic environment, supply and demand within online advertising markets, and quality of advertising platforms. However, trends in CPC changes seem to be unique to each firm. For instance, Yahoo’s CPC increased by 11% in the 2015 due to increased activity in the Americas region.(20) Despite its superior financial performance, Google has seen its CPC decrease 5% and 11% in 2014 and 2015, respectively. Google cites various reasons—proportion of cheaper Youtube ads, geographic mix, foreign exchange, etc.—for the downward trend.(7) Overall, it is difficult to find industry wide drivers of CPC given the varying business models within the industry. Our team does expect Google’s CPC to continue to decrease due to the company’s changing geographic mix. Increased activity in emerging markets, such as India, will drive down prices. On average, CPC in India is 77% less than in the U.S.(21) Furthermore, Google’s revenues in European markets, where it has been historically able to charge higher prices, will become smaller proportionally.

Source: Wordstream(21)

Industry Trends Increasing Mobile Activity Consumers are increasingly using mobile devices to find and use information. By 2017, researchers estimate 54% of phones globally and 86% of phones in North America will be used to access the Internet.(22) More people are also being introduced to mobile device capabilities. Global mobile internet penetration has increased over the past two years and is expected to continue in 2016 and 2017. Overall, mobile activity should grow as the consumer population increases and turns to mobile devices for information.

Source: PwC(22)

Increased mobile activity presents opportunities to companies in the search industry. Although they are tasked with developing new mobile platforms, search companies will benefit from the mass-generation of data and direct access to consumers. Advertising on mobile devices is a chance to refine or even expand product lines. Search companies have been active in developing their mobile platforms. In 2013, Baidu acquired 91 Wireless for $1.9 billion in order to gain access to more mobile users.(23) Google has also made acquisitions with the same intent. Its recent purchase, Apigee, should allow Google to refine its mobile platform through API improvements. Overall, it is likely that search companies will continue to invest heavily to improve their mobile platforms and appeal to mobile users. Artificial Intelligence Companies in the technology sector are developing digital assistants powered by artificial intelligence. Since the release


of Apple’s Siri, other key industry players have developed their own mobile services, such as Microsoft’s Cortana and Alphabet’s OK Google. Ventures into digital assistance and artificial intelligence have also created physical product lines capable of search functions. Competition within these new spaces will likely grow as products like the Amazon Echo and Google Home become more popular. While digital assistants are increasingly being incorporated into devices and platforms, consumers are still adapting to the new technology. For example, only 3% of iPhone users are comfortable using Siri in public.(24) Our team predicts growth in this area will come as consumers become more familiar with artificial intelligence; however, we do not expect digital assistants to compete with search engines in upcoming years. Competition The search industry continues to be attractive for investors. During periods of economic growth, businesses will have greater discretionary income for advertising. Additionally, revenues are shielded from negative consequences of the business cycle. Businesses often seek to reduce advertising expenses during downturns by concentrating on search engines. The search industry’s propensities for high concentration and significant barriers to entry provide a suitable environment for further development of the current market leaders. Although the search industry is not commonly recognized for its regulatory environment, upcoming litigation may be influential. There are currently multiple anti-trust charges against Google for its practices in Europe. In general, anti-trust policies oppose the natural environment of the search industry, in which economies of scale promote large search engines. Courts around the world are also considering arguments on censorship. Decisions on this issue will have direct effects on the search industry as data-collection processes will need to be adjusted. Comparable Companies Our group collected information on all previously discussed competitors, except for Amazon, which does not focus on advertising revenue. When applicable, we also provided data for recent changes in paid clicks and cost-per-click because they indicate current growth. Alphabet has the highest advertising revenue by a significant margin, which is consistent with its large market share. Baidu has also experienced material change in paid clicks because of the strong growth in the Chinese market.

Company P/E Ad

Revenue Paid Clicks

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click change GOOGL 26.6 67,390 22.00% -11.00% YHOO 67.8 5,789 6.00% 11.00% BIDU 37.8 9,885 40.20% Undisclosed FB 28.3 17,079 Undisclosed Undisclosed

Porter’s Five Forces Industry Rivalry: Moderate The search industry is highly concentrated with Google taking the vast majority of the market share. High concentration leads to cost per click disparities between industry leaders, since Google’s dominance allows the company to charge premiums for its online advertising. While Google’s search engine continues its strong performance, its competitors have struggled. Yahoo has posted negative profits and will likely be acquired by Verizon. Bing has also faced challenges. In 2015, the company had to resort to offering rewards programs in an effort to gain customers.(25) Overall, Google is the industry leader within the highly concentrated space, and our group predicts that it will maintain its position. New Entrants: Low The nature of the industry presents significant challenges for new entrants. The largest search engines attract the most users, which leads to better collected data and more accurate results. In return, users are more likely to be drawn towards or return to the platform, creating a feedback loop promoting already established engines. Additionally, with more than 45.0% of information technology spending worldwide expected to come from large enterprises by the year 2020, companies with strong brand recognition and established consumer bases will be able to weather industry uncertainty far better than emerging start-up companies.(26)

Threat of Substitutions: Low Search activities are engrained in consumer behavior—consequently, companies within the industry face a low threat of substitution. Users are always going to seek information and search engines will continue to serve as solutions. Platforms will likely change, but the fundamental service will remain valuable. Power of Suppliers: Low Companies in the search industry are largely immune to pressure from suppliers. Search engines primarily run off proprietary algorithms built in-house or licensed from an existing industry player. Additionally, these companies do not purchase raw materials or build inventories—their databases are developed through continued activity from consumers. Power of Customers: Moderate There are few advertising alternatives to search due to the declining popularity of traditional advertising and increasing popularity of search engines. While advertisers can switch search engine providers to reduce cost per click rates, they would likely be faced with smaller user bases and less relevant results. Catalysts for Growth and Change Internet Penetration Internet penetration will continue to drive growth within the search industry. While the U.S. and European markets are nearly saturated, internet penetration still remains low in


emerging countries. As discussed earlier, India presents a unique opportunity for growth given the spread of internet access throughout the region. While our team believes aggregate internet penetration will provide growth for search companies in the short term, we do not foresee long-term opportunities. Markets will eventually become more saturated, causing growth figures to decline. Consolidation Within Industry Within the search and online advertising industries, major players seek to increase access to consumers and their data. Companies have recently expanded their user base through mergers and acquisitions. Verizon’s purchase of Yahoo positions the communications company to further connect with end users. Similarly, Microsoft’s acquisition of LinkedIn offers access to professional networks. Although these ventures are costly, our team expects similar behavior to continue. Key players in the technology sector continue to generate substantial cash flows and will seek opportunities to reinvest in the future.

General Information Overview and Business Description: Alphabet is a multinational public holding company that operates within the technology sector. The organizational structure was established in October 2015 after Google founders Larry Page and Sergery Brin sought to separate core and non-core business lines. Google and its affiliated services (e.g., Youtube, Android, Gmail, Chrome) have remained as Alphabet’s legacy business and continue to generate the majority of the company’s annual revenues. Alphabet’s other businesses are often referred to as “Other Bets” and are commonly known for their ambitious and innovative missions. Excess cash from Google’s operations has been utilized historically to fund these “moonshots”.(7)

Google’s corporate strategy is to further penetrate the constantly changing and growing digital population. As consumers turn more often to mobile phones and new devices, Google seeks to expand its platform and reposition itself to predict changes in consumer behavior.

Despite going public over ten years ago, Google has remained in the growth stage of its life cycle. Google’s revenue growth has been strong, specifically between 2011-2014 when its annual growth rates exceeded 15% each year. While Google’s revenue growth rate declined in 2015, the company’s annualized rate over the past five-year period was still 19.3%.(7) Additionally, Google continues to expand its platform, introducing Google Accelerated Mobile Pages and the Pixel smartphone within the past 12 months. Overall, the digital advertising industry is still growing and developing based on changes in customer behavior. Revenue growth and expansion of platforms is likely to come for Google and other key players within the industry.

Source: IBIS – Search Engine Industry Analysis(27)

Google continues to improve its search engine and develop its network. While acquisition costs were low in the past year, Google had been active in M&A market, especially 2014 when it spent approximately $5 billion. Acquisitions have added value to the platform by expanding and improving Google’s core features.(7) For example, Google’s acquisition of Waze helped further develop mapping technologies. Waze is now central to Google’s venture into the ride-sharing industry. Google has also continued expand its research and development, expensing approximately $2.45 billion more in the past fiscal year than in 2014.(7) Expectations for future financial performance are ultimately positive, as Google seems to have provided capital to foster future innovation and stay ahead of changes in consumer behavior. Products and Markets: Google’s primary product is its search engine, which it offers to all internet users at no cost. This user base is then utilized to attract advertisers, who provide revenue for the search engine. Revenue from advertisers is generated through two primary streams: performance advertising and brand advertising. Performance advertising seeks to actively engage viewers. In this model, advertisers generally pay for each user click, which is the driving metric for successful advertising. Brand advertising seeks to enhance user awareness of the advertiser rather than enticing action from the consumer. In this model, advertisers pay for on a cost-per-impression basis based on the number of times advertisements are displayed on Google and affiliated websites. Success with its search engine requires Google to attract and retain interest from users, advertisers, and content providers. Users are attracted by the relevancy and efficiency of search results. Advertisers are attracted by the size and engagement

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of the current user base. Content providers, also known as Google Network Members, consist of all parties who source advertisements through Google. Content providers are attracted by the size of the current advertiser base. As the industry leader, Google has no significant marketing initiatives, since further differentiation comes from research and development rather than greater brand awareness. Google has no long-term contracts with advertisers and low customer concentration. From 2013 to 2015, no customer has comprised over 10% of revenues.(7) Production and Distribution: Google’s search engine is developed through proprietary algorithms, two of which are colloquially referred to as spiders and indexers. Spiders search through the internet and pull information on all possible websites; indexers catalogue these databases appropriately in order to provide the most relevant search results for queries. These algorithms determine how well the search engine operates and will generally be updated and improved by software and technology engineers. Speed and bandwidth of the search engine are determined by relationships with telecoms companies that control internet pipelines and access; these relationships can be improved through new contracts. Advertisers are managed through Google AdWords, which auctions key words and phrases to the highest bidder. In this model, the highest bidders have their advertisements appear at the top of any searches for those words or phrases. Because of the auction process, Google has minimal direct interaction with advertisers. Advertising content is also provided to Google Network companies, which are independent entities that source the advertisements shown on their websites through Google. The allocation of advertisements in this manner is managed by a program called Google AdSense. Revenues from advertisements on Google have a higher profit margin than those appearing on Google Network websites, due to the additional fees associated with incorporating the Network companies. Analysis of Earnings and Guidance Calls: Google is classified within the software industry, in which growth will be driven by consumer shifts to mobile devices and producer shifts to cloud products. Currently, Google is well-positioned to capitalize on both of these factors. In Q3 2015, Google launched an initiative to improve advertisement format and delivery for mobile users; their implemented program indexes pages specifically to provide optimization on mobile devices. At the end of Q2 2016, there were over 150 million pages in the index, with an average growth of 4 million added every week.(28) Expanded text ads and bid adjustments by device type have been added to the product offerings, which further develops Google’s adjustment to mobile searches. As a result, mobile users were a primary driver in Google’s 23% year-over-year growth. Other revenue increased 39% year-over-year, which was driven by growth in Cloud products. Cloud and mobile app offerings have been designated as a priority area; the “vast majority” of new hires

to the firm are engineers and product managers assigned to further develop these areas. (29) While management discussed Google’s RankBrain in-depth at the end of Q2 2016, it glossed over the subject during the recent earnings call. RankBrain utilizes machine learning to provide more accurate search results. In a recent test, the software was able to accurately guess users’ favored results with 80% accuracy.(28) Although RankBrain offers innovation in search engines, it does not offer any differentiation. For example, Microsoft has Cortana Intelligence for Bing, which was able to synthesize information and predict the 2014 US mid-term elections with 95% accuracy.(35) Without notable improvement to user experiences, RankBrain is unlikely to drive growth for Google, especially given the management estimated 10-year time frame for results. During the Q3 2016 earnings call, management emphasized the effectiveness of Alphabet’s corporate structure despite a $665 million operating loss from Other Bets over the quarter. To substantiate the performance, Alphabet’s management pointed to the fact that many of the company’s projects are still in early stages and should be viewed over longer horizons.(29) Our group recognizes the uncertainty in forecasting performance for Alphabet’s Other Bets, but we do not want to overlook potential revenues from projects like Nest or Verily. Competition Google is the leader within the search engine industry. Within the U.S. economy, Google has 67.3% of the market share. The only true competitors within the space are Bing and Yahoo with 18.2% and 10.8% market share, respectively. While search engines like Baidu and Naver may dominate their own respective regions, Google has remained dominant across most foreign markets. In India and the European Union, Google has 97% and 92.38% market capitalization, respectively.(30) Overall, Google’s search engine and brand continue to attract and retain users. Baidu is Google’s sole competitor outside of the U.S. economy. While censorship and performance issues derailed Google’s venture into the Chinese market, Baidu has grown and now functions as China’s lead search engine. Baidu has over 80% of the market share and generates more digital advertising revenue than any other technology companies in the Chinese economy. Although Google is likely to dominate the U.S. market in the foreseeable future, Baidu still has opportunities for growth. In 2016, analysts estimate digital advertising in China to exceed $40 billion in revenues. Consequently, Baidu will likely sustain its growth and have sufficient capital to rival Google in subsequent industry ventures.


Sources: eMarketer estimates for 2016, Bloomberg(31) Google also competes with companies in other industries. Amazon has become the premier platform for online commerce and, consequently, product searches. In the past year, 44% of consumers started their product searches on Amazon as opposed to search engines or retailers. Product searches are important to Google’s search engine, as they account for 21% of all internet searches.(18) Ultimately, the shift in consumer behavior threatens Google’s revenue growth as potential opportunities for advertising are transferred to Amazon. Companies that generate revenue through online advertising, such as Facebook, also compete with Google to attract marketing and advertising funds. Facebook experienced major ad revenue growth in the first quarter primarily driven by advertisements on mobile devices.(32) Moreover, Facebook has hinted it may utilize personal data from WhatsApp to further enhance its strategic advertising services. Other Topics Research and Development: Google must consistently pursue research and development (R&D) in order to remain competitive and avoid losing market share and revenue to competitors. Besides in-house endeavors, Google will also seek potential acquisitions in order to improve their technology. Google’s R&D expenditures extend beyond the search engine business, because many of Google’s peripheral operations involve untested products which require significant innovation. Google’s total R&D expenditures have historically increased, and non-search engine investments will continue to be a primary driver of this overall growth.

Source: Alphabet 2015 10K(7)

Government Regulations: Google faces most issues with governmental regulation in the European Union. In the past twelve months, the EU has formally brought forward four antitrust lawsuits against Google. The most notable charge against Google is for forcing smartphone manufacturers to pre-install Google software. If the EU rules against Google, the company may be required to re-evaluate its corporate strategy. Furthermore, the decision may provide justification against Google’s similar practices in India and China.(33) Catalysts for Change/Growth Internet Users in India: Because revenues are dependent on user activity, Google must grow its user base in order to gain a higher click through rate and attract advertisers. India is currently the driver of global smartphone growth, with growth to 402 million users in December from 375 million in October. Furthermore, India has provided 118 million new mobile-data users in the past year. Internet penetration is currently 30%, falling far short of both China and the US.(34) This region will be a common target for expansion from software companies, but Google’s strategic railway partnerships and mobile initiatives provide a strong position to benefit from both the growth in mobile devices and general internet access. Consumer Shift to Mobile Devices: Mobile advertising has experienced strong growth, reaching over 30% of revenue in 2015, compared to 5% in 2010.(27) Ignoring growth from smartphone sales, mobile advertising revenues experienced significant increases because consumer utilize search engines differently when on mobile devices. Unlike desktop searches, mobile users are often more inclined towards consumption in their searches, leading to higher chance of engagement with advertisements and therefore more revenue for Google. The movement to mobile devices requires software and algorithm changes due to different processing and display capabilities for mobile, but Google has been investing to meet this change since Q3 2015.(28) Platform Integration: Platform integration offers an avenue for consumer attraction and retention. Creating efficiencies with products outside of the search engine produces and opportunity to attract new customers who use peripheral offerings, such as Google Chrome and Android, and simultaneously retains current users of multiple products. Further integration will drive customer competition as internet and search engine users reach saturation. Although Google offers many relative efficiencies, this feature alone does not provide any differentiation. Microsoft has many other related products, and Yahoo will have a strong smartphone access channel following its acquisition by Verizon. However, Google’s current position as the industry leader offers advantage, because the firm will have to focus significantly less effort towards further innovation, and will only need to ensure that it keeps pace with competitors.

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Alphabet R&D Expenses


S.W.O.T. Analysis Strengths: Google’s strength relies on its innovation and brand name. Its search engine continues to generate revenues and supply cash flows to support research and development. Overall, Google has capital available to fund modifications to stay in front of changes in the digital advertising industry. Google’s brand name will also be an asset as internet services expand to new users, specifically within developing markets. Weaknesses: Google’s corporate structure is a potential weakness. Following the company’s organizational shift to Alphabet, core and non-core segments have been separated in financial reporting. While the change highlights the strong performance of Google, the inadequacy of “Other Bets” is also more evident. In the past fiscal year, these ventures heavily consumed Alphabet’s cash balance without contributing more than 1% annual revenues.(7) Overall, Alphabet’s organizational structure has contributed more doubt regarding management, rather than refocusing attention to Google’s stellar performance. Opportunities: There are many opportunities for Google to develop and expand its platform. Google recently announced the release of its own messaging app, Allo. The goal is for Google to maintain user activity within its platform and analyze personal data to further enhance the Google search engine. Overall, Allo should increase the number of clicks within the Google platform and provide more leverage for Google when marketing to advertising companies. Google can also benefit from partnerships with smartphone manufacturers in China and India. Both countries have rather low internet penetration rates compared to the United States, but the number of daily users is growing rapidly through the smartphone boom. If Google can establish partnerships with major smartphone providers, it would have the opportunity to vastly grow its user population and, consequently, annual revenues. Threats: Ad blocking may be a threat to Google’s search engine. Over the past twelve months, ad blocking in the U.S. increased by 48%. Furthermore, ad blocking penetration is only 15%, so future growth is likely to continue.(34) Ad blocking would create a material adverse effect on Google’s per-click revenues. Google may also be hurt by increased numbers of in-app searches. Amazon already dominates the retail search space, but other companies offer popular alternatives to searches on Google’s platform. For example, consumers are turning to apps like Yelp! rather than Google to find restaurants or accommodations. If this behavioral shift continues, Google will lose out on the potential search revenues.

We are issuing a BUY rating on Alphabet, Inc. with a target price range of $900 - $950. We forecasted future revenues and key expenses by using relevant metrics and growth proxies; we estimated a cost of capital and specific continuing value assumptions in accordance with our economic outlook. We then analyzed the intrinsic value of the stock through the Discounted Cash Flow Model, Economic Profit Model, Dividend Discount Model, and a relative P/E valuation. Revenue Projection Alphabet revenues are reported in two operating segments: Google, which includes internet and hardware products, such as Search, Ads, YouTube, and Chromecast. The Google segment can be further segmented into Google Websites, Google Network Members’ websites, and Other revenues. All other segments within Alphabet fall below the qualifying threshold for reportable segments, so they are combined and reported as Other Bets, which includes Nest, Google Fiber, Verily, Google Capital, and other non-material businesses. Google Websites Aggregate paid clicks and cost-per-click are important revenue drivers in the search engine industry. Although the specific number of clicks and cost-per-click are not disclosed, Alphabet reports the annual change in both metrics, which we can forecast and then use to approximate growth in the overall Google Websites segment. Yearly changes in these metrics are attributed to various factors, such as general economic conditions, advertising format, composition of emerging and mature markets, and proportional non-click based revenue in Google Websites. Given our economic forecast on continued growth, we do not anticipate any drastic changes in either of these metrics. We forecasted the change in paid clicks and cost-per-click by taking a five-year historical average, with outliers removed, for resultant 23% and -9% growth rates, respectively. Internet penetration also impacts the forecasted growth rate through two opposing effects: a larger internet user base implies that Alphabet has a larger consumer base, however, it also implies a smaller potential for future consumer expansion. Using projections from eMarketer, we calculated an average decline of approximately 10% in the future growth rate in internet users. The associated increase in revenue is reflected in the forecasted change in aggregate paid clicks above, but we still need to incorporate the 10% decline in future potential into the final revenue forecast. To estimate segment revenues for 2016, we used the unaudited statements for the first three quarters of the year, which resulted in an 18.5% growth rate from the previous year. To forecast this growth rate for the rest of the projection period, we took the calculated 18.5% growth rate for 2016 and adjusted for the increases and decreases from aggregate paid clicks, cost-per-click, and internet penetration.

VALUATION ANALYSIS


Google Network Members’ Websites Google Network Members are outside parties who source relevant advertising from Google. As with Google Websites revenue, this segment is driven by paid clicks and cost-per-click. Historically the changes in click metrics were combined for Google Websites and Google Network Members’ Websites. However, Alphabet has separated data for 2014 and 2015, which illustrate a significant declining trend in Network Members. When both segments were reported together, Alphabet had a 25% increase in paid clicks. Once separated, Google Network Members’ Websites decreased to a marginal 2% growth in 2014, followed by a -7% growth in 2015. The cost-per-click metric is slightly more optimistic, changing from -8% growth in 2013 to -3% growth in 2015. Our group anticipates that the decline in paid clicks will continue over the projection period; we reached our specific estimate by taking an average of the past two years in order to avoid any inflation from the Google Websites segment. The same approach was used to forecast the forward-looking change in cost-per-click. Using the reported data from the previous three quarters, our group estimates that this segment will report -0.5% growth for 2016, which aligns with our prediction of a continued decrease. To forecast segment revenue growth for the remainder of the projection period, we applied to same approach used for Google Websites: we took the initial -0.5% growth and then adjusted for growth in paid clicks, change in cost-per-click, and internet penetration. Google Other Revenues Google other revenues are comprised of sales through the Google Play store, hardware sales, licensing fees, and select service fees. Of these components, the Google Play store is the primary driver of revenue growth; therefore, our projection was concentrated on forecasting a growth rate in mobile apps. Using projections from Statista, we determined a 22% five-year CAGR for mobile app revenue. To support this projection, we also calculated an estimate for 2016 Other Revenue from the current quarterly statements. Using an average of the first three quarters in place of exact fourth quarter results, we calculated a growth rate of 26% from 2015. We chose to use 26% for 2016 specifically, and 22% for all subsequent years in the projection period. Other Bets Although Other Bets contains various businesses within Alphabet, total revenue is primarily driven by Google Nest, which sells smart home products, and Google Fiber, which offers fiber-optic internet connection services. Given the recent slowdown in Google Fiber(27), we will focus on Google Nest and smart home devices to project future revenues for Other Bets. We chose to use a 67% five-year CAGR in smart home device shipments from Business Insider as a growth proxy. To support our assumption, we calculated an estimate for Other

Bets using the past three quarterly reports, which resulted in an estimated 2016 growth rate of 67%. We also elected to use a lower growth rate in 2021 following the five-year period in order to capture saturation from continued customer adoption. Cost of Goods Sold Projection Alphabet’s cost of goods sold (COGS) includes depreciation expense, however, our group has separated these two line items in our forecast. COGS is primarily driven by traffic acquisition costs (TAC), which are incurred from interaction with Google Network Members and distribution partners. Because of the necessary TAC for Google Network Members, revenues generated in this segment have a lower margin than revenues from Google Websites; therefore, revenue composition also has a material impact on COGS as a percentage of total sales. Historical data supports this correlation. Alphabet has experienced a decreasing COGS, from 39.61% of sales in 2013 to 37.56% of sales in 2015. The decline is accompanied by declining growth in Google Network Members’ Websites revenues and strong growth in Google Websites revenues. Our group used this relationship in conjunction with our revenue projections to forecast COGS. Alphabet has decreasing annual growth in TAC, declining from 24.34% in 2012 to 6.27% in 2015. Our group predicts that the decreasing growth will continue following the decline in Google Network Members revenues. The slowing growth in TAC will result in a lower nominal COGS, and the resulting increased contribution margin of Google Websites will decrease COGS as a percentage of sales. To capture these effects, our group forecasts COGS to be 37.54% of sales, which falls slightly below 2015 COGS. Although we target lower COGS, we refrained from a strong decrease in order to account for management guidance provided in the third quarter report of an increase in COGS. Weighted Average Cost of Capital We calculated the weighted average cost of capital with market weights of 97.74% equity and 2.26% debt. Equity was calculated from market capitalization, and debt values were taken from the balance sheet. Debt values are sourced from the projected 2016 values, which account for recent debt issuances and repayments disclosed in the third quarter report. Of Alphabet’s three classes of stock, Class B shares possess significant voting power and are not traded publicly, so they were not included in the calculation of market value of equity. Cost of Equity Cost of equity was determined using the capital asset pricing model. We calculated a five-year weekly Beta of 1.063 from Bloomberg. We determined an equity risk premium of 6.26% from the implicit equity risk premium given by Aswath Damodaraniv. The risk-free rate was set at 2.99%, the yield on a 30-year treasury bond on 11/14/2016.


Cost of Debt: Alphabet has no long-term bonds outstanding; therefore, we calculated the cost of debt based on the company credit rating and the associated default premium. Alphabet bonds have an Aa2 rating from Moody’s(28) and this rating carries a default risk premium of 0.78% according to Aswath Damodarani, therefore, we calculated the cost of debt by adding the premium to the calculated above, for a resultant 3.77% pre-tax cost of debt. CV Growth Assumptions We set the continuing value of growth for both NOPLAT and EPS at 2%, which aligns with our projection for long-term growth in GDP. This value falls well below our predicted growth during the projection period, but we aimed to avoid any value inflation from over-optimistic terminal growth. Although Alphabet has high growth prospects, we do not believe that it can perpetually outperform the overall economy. We forecasted the continuing value of ROIC as 55%. Our projections include a decline in ROIC for several years and a subsequent increase. The 55% was chosen in relation to the average of these moving values and is conservative compared to historical data. We forecasted the continuing value of ROE as 14.84%, which corresponds to the predicted value of the ratio in the final year of our projection period. Share Repurchases In October 2016, the company was authorized to repurchase up to $7,019,340,976.83 of its Class C capital stock; the repurchase plan has no targeted end date. A previous announcement of share repurchases was announced on October 2015 and completed in June 2016. Therefore, we predict that the current repurchase will also be completed by the end of 2017 and have incorporated it accordingly into the model during that time frame. Discounted Cash Flow and Economic Profit Models We believe that the discounted cash flow and economic profit models yield the most accurate valuation of Alphabet’s stock: $926.48 as of 11/15/2016. Our DCF and EP models forecast NOPLAT to increase over the projection period with nominal continuing values of $702.85308 billion and $598.56333 billion, respectively. After adjustments are made to reconcile the value of operating assets to the value of equity, the intrinsic value of the stock is projected to the current date according to the stock price appreciation formula. All other key assumptions have been previously discussed. Dividend Discount Model Alphabet currently pays no dividends and management has made no indication of any plans to begin, therefore we did not include dividends in our model. Instead, we calculated the theoretical dividend that Alphabet could pay, using the

retention and payout ratios calculated by terminal growth and ROE. Assuming these theoretical dividends, Alphabet has an intrinsic stock price of $714.02 as of 11/15/2016. We project EPS to increase over the projection period with a nominal continuing value of $774.05/share. The share price has also been adjusted by the stock price appreciation formula to reflect a current valuation. This valuation falls significantly below the result from the DCF/EP models, but it also has less credibility because of Alphabet’s historical lack of dividends. Relative P/E Valuation We chose price-to-earnings as a comparative metric because of its inclusion of growth prospects, which have strong influence within the technology sector specifically. Relative valuation yields a price of $1764.10 in 2016 and $1446.82 in 2017 as of 11/15/2016. We included all competitors discussed previously in the report, however, the valuation is inflated because not all competitors operate exclusively within the search engine industry. For example, Facebook derives revenue from advertisements, but serves primarily as a social media platform. Amazon competes with Alphabet for consumer searches, but it operates primarily as an online retailer and marketplace.

Paid Clicks Growth vs. Cost-per-click Growth Our group used movement in click metrics to forecast revenue growth, so the determination of these numbers will have a material impact on our final valuation. Although their growth rates have seemed to converge over the past several years, they have historically tended to move 10% or more in any given year. Due to their historical volatility, we tested against a potential 2% movement in long-term growth projections; coincident movements in both metrics yield a valuation from $881.35 - $980.86. COGS vs. SG&A Expense Cost of goods sold (COGS) and selling, general, and administrative (SG&A) expenses comprise the largest proportion of expenses. Both research and development (R&D) and depreciation expenses are also significant items on the income statement, but they were not sensitivity tested because our model does not capture any associated revenues that would arise from increases to R&D or depreciation expenses. To exclude these effects, COGS is reflected without any depreciation expense. Although Alphabet segments SG&A into Sales and Marketing expenses and General and Administrative expenses on the income statement, they have been combined into SG&A for this analysis. A coincident movement of 1% in both expenses yields a valuation from $875.00 - $977.96.

SENSITIVITY ANALYSIS


CV ROIC vs. CV NOPLAT This sensitivity analysis aims to show the impacts of our primary continuing value assumptions. A coincident movement of 1% yields a valuation from $854.78 – $1020.80. Additionally, the price fluctuations are primarily driven by changes in CV NOPLAT rather than CV ROIC, which reinforces our group decision to select a conservative 2% value for CV NOPLAT. Beta vs. Risk Premium This sensitivity analysis seeks to test the impacts of changes in WACC on the valuation, since beta and the risk premium are primary components in the WACC calculation. Holding the other variable constant, a 1% change in risk premium yields a valuation from $814.77 - $1075.17, while a 0.2 change in the beta yields a valuation from $797.78 - $1106.88. Our group was particularly interested in testing a wide range of beta values because the three-year monthly beta is 0.88, which falls notably below our calculated five-year weekly beta of 1.06. Overall, these assumptions have the most significant influence over the final valuation. Our group is optimistic about the low probability of the worst-case scenario because the implicit risk premium calculated by Aswath Demodaran is well above the historical risk premium observed in the markets. Risk-Free Rate vs. Marginal Tax Rate Our group wanted to test these assumptions because they both impact the final WACC calculation and the marginal tax rate impacts the calculated value drivers. Our group was specifically interested in changes in the risk-free rate following the volatility and uncertainty in interest rates from recent the presidential election. Coincident movements of 0.5% in the risk-free rate and 2% in the marginal tax rate yield a valuation from $871.65 - $989.22. This price range is primarily driven by changes in the risk-free rate; in comparison, the marginal tax rate has near negligible effects on the final valuation.


Important Disclaimer This report was created by students enrolled in the Applied Equity Valuation (FIN:4250) class at the University of Iowa. This report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge, and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.


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Alphabet Inc.

Key Assumptions of Valuation Model

Ticker Symbol GOOGL

Current Share Price $772.35

Current Model Date 11/15/2016

Fiscal Year End Dec. 31

Pre‐Tax Cost of Debt 3.77%

Beta 1.063

Risk‐Free Rate 2.99%

Equity Risk Premium 6.26%

WACC 9.49%

CV Growth of NOPLAT 2.00%

CV Growth of EPS 2.00%

CV ROIC 55.00%

CV ROE 16.01%

Current Dividend Yield 0.00%

Marginal Tax Rate 25.00%

Alphabet Inc.Revenue Decomposition

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021Google Segment

Google websites 37422 45085 52357 62043 73602 87410 103924 123696 147395Growth Rate 19.86% 20.48% 16.13% 18.50% 18.63% 18.76% 18.89% 19.03% 19.16%

Google Network Members' websites 13650 14539 15033 14958 14895 14843 14799 14763 14732Growth Rate 9.51% 6.51% 3.40% -0.50% -0.42% -0.35% -0.29% -0.25% -0.21%

Google advertising revenues 51072 59624 67390 77001 88497 102253 118723 138459 162127Growth Rate 16.91% 16.74% 13.02% 14.26% 14.93% 15.54% 16.11% 16.62% 17.09%

Google other revenues 4435 6050 7151 9010 10993 13411 16361 19961 24352Growth Rate 88.48% 36.41% 18.20% 26.00% 22.00% 22.00% 22.00% 22.00% 22.00%

Google segment revenues (advertising and other) 55507 65674 74541 86011 99489 115664 135085 158420 186479

Other BetsOther Bets revenues 12 327 448 748 1249 2087 3485 5819 8147

Growth Rate 2625.00% 37.00% 67.00% 67.00% 67.00% 67.00% 67.00% 40.00%Total Revenues 55519 66001 74989 86759 100739 117750 138569 164239 194626

Growth Rate 20.59% 18.88% 13.62% 15.70% 16.11% 16.89% 17.68% 18.52% 18.50%

Google WebsitesChange in Paid Clicks 25.00% 20.00% 22.00% 23.00% 23.00% 23.00% 23.00% 23.00% 23.00%Change in Cost-Per-Click -8.00% -5.00% -11.00% -9.00% -9.00% -9.00% -9.00% -9.00% -9.00%

Google Network MembersChange in Paid Clicks 25.00% 2.00% -7.00% -2.50% -2.50% -2.50% -2.50% -2.50% -2.50%Change in Cost-Per-Click -8.00% -6.00% -3.00% -4.50% -4.50% -4.50% -4.50% -4.50% -4.50%

Alphabet Inc.Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021Revenues 55519 66001 74989 86759 100739 117750 138569 164239 194626Cost of revenues 18054 20712 23101 27329 31733 37091 43649 51735 61307Depreciation & Amortization Expense 3939 4979 5063 5237 5687 6237 6901 7701 8661Gross Profit 33526 40310 46825 54193 63319 74422 88018 104803 124658Research & development expenses 7137 9832 12282 13014 15111 17663 20785 24636 29194Sales & marketing expenses 6554 8131 9047 10412 12089 14131 16629 19710 23357General & administrative expenses 4432 5851 6136 7374 8562 10008 11777 13959 16542Charge related to the resolution of Department of Justice investigation 0 0 0 0 0 0Total costs & expenses 40116 49505 55629 63366 73182 85130 99743 117740 139061Income from operations 15403 16496 19360 23393 27557 32621 38826 46498 55566Interest Income 766 746 999 848 829 986 1213 1481 1794Interest Expense 81 101 104 156.6 118 148 148 148 148Other Income -189 118 -604 43 50 59 69 82 97Impairment of equity investments 0 0 0 0 0 0Income before income taxes 15899 17259 19651 24128 28319 33517 39961 47914 57309Provision for income taxes 2739 3639 3303 4826 5664 6703 7992 9583 11462Net income from continuing operations 13160 13620 16348 19302 22655 26814 31969 38331 45847Net income (loss) from discontinued operations -427 516 0 0 0 0 0 0 0Net income 12733 14136 16348 19302 22655 26814 31969 38331 45847Less: Adjustment Payment to Class C capital stockholders 0 0 522Net income available to all stockholders 12733 14136 15826 19302 22655 26814 31969 38331 45847

Basic net income (loss) per share of Class A and B common stock: Continuing Operations 19.77 20.15 23.11 Discontinuing Operations -0.64 0.76 0.00Basic net income per share of Class A and B common stock 19.15 20.91 23.10 28.32 33.47 39.55 47.15 56.53 67.62Number of Shares Outstanding 665 676 685 681 677 678 678 678 678

Alphabet Inc.Balance Sheet (in millions)

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021AssetsCurrent Assets:

Cash & cash equivalents 18898 18347 16549 26028 41234 63601 90010 120853 157658Marketable securities 39819 46048 56517 56918 57322 57729 58139 58552 58968Total cash, cash equivalents, & marketable securities 58717 64395 73066 82946 98556 121330 148149 179405 216625Accounts receivable, net 8882 9383 11556 13014 15111 17663 20785 24636 29194Inventories 426 0 0 0 0 0 0Receivable under reverse repurchase agreements 100 875 450 651 756 883 1039 1232 1460Deferred income taxes, net 1526 1322 724 850 1006 1199 1437 1719Income taxes receivable, net 408 1298 1903 1689 1982 2346 2797 3354 4012Prepaid revenue share, expenses & other assets 2827 3412 3139 3731 4332 5063 5958 7062 8369

Total current assets 72886 80685 90114 102754 121586 148291 179928 217126 261379Prepaid revenue share, expenses & other assets, non-current 1976 3280 3181 3731 4332 5063 5958 7062 8369Non-marketable investments 1976 3079 5183 6507 7555 8831 10393 12318 14597Property & equipment, gross 23837 32746 40146 48854 58570 69517 81961 96231 112677Less: accumulated depreciation & amortization 7313 8863 11130 15482 20488 26200 32698 40087 48509Property & equipment, net 16524 23883 29016 33371 38082 43317 49263 56144 64168Intangible assets, net 6066 4607 3847 2962 2281 1756 1352 1041 802Goodwill 11492 15599 15869 15869 15869 15869 15869 15869 15869Total assets 110920 131133 147210 165194 189705 223128 262764 309561 365184

Liabilities and Stockholders' EquityCurrent Liabilities

Accounts payable 2453 1715 1931 2603 3022 3533 4157 4927 5839Short-term debt 3009 2009 3225 0 1000 1000 1000 2000 2000Accrued compensation & benefits 2502 3069 3539 4056 4709 5504 6478 7678 9098Accrued expenses & other current liabilities 3755 4434 4768 5206 6044 7065 8314 9854 11678Accrued revenue share 1729 1952 2329 2256 2619 2944 3326 3777 4282Securities lending payable 1374 2778 2428 2169 2518 2708 2910 3121 3309Deferred revenue 1062 752 788 737 856 1001 1178 1396 1654Income taxes payable, net 24 96 302 410 481 570 679 815 974

Total current liabilities 15908 16805 19310 17436 21251 24325 28042 33568 38833Long-term debt 2236 3228 1995 3938 3938 3938 3938 2938 2938Deferred revenue, non-current 139 104 151 304 353 412 485 575 681Income taxes payable, net, non-current 2638 3407 3663 4102 4814 5698 6793 8145 9742Deferred income taxes, net 1947 1971 -62 41 48 57 68 81 97Other long-term liabilities 743 1118 1822 1735 2015 2355 2771 2464 1946Class A & class B common stock & additional paid-in capital 25922 28767 32982 34738 36731 38974 41329 44121 47429Accumulated other comprehensive income (loss) 125 27 -1874 -1874 -1874 -1874 -1874 -1874 -1874Retained earnings 61262 75706 89223 104775 122430 149244 181212 219543 265390Total stockholders' equity 87309 104500 120331 137639 157287 186343 220667 261790 310946Total liabilities and stockholders' equtiy 110920 131133 147210 165194 189705 223128 262764 309561 365184

Alphabet Inc.Cash Flow Statement

Fiscal Years Ending Dec. 31 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Operating ActivitesNet income 3077 4204 4227 6520 8505 9737 10737 12920 14444 16348

Depreciation & amortization of property & equipment 494 808 1212 1240 1067 1396 1988 2781 3523 4132In-process research & development 11 - - - - - - - - -Amortization of intangibles & other assets 78 160 288 284 329 455 974 1158 1456 931Stock-based compensation expense 458 869 1120 1164 1376 1974 2692 3343 4279 5203Excess tax benefits from stock-based award activities -582 -379 -159 -90 -94 -86 -188 -481 -648 -548Deferred income taxes - -164 -225 -268 9 343 -266 -437 -104 -179Loss (gain) on divestiture of business - - - - - - -188 -700 -740 0Impairment of equity investments - - 1095 - 0 110 0 0 - -Loss (gain) on equity interest - - - - - - - - -126 -Loss (gain) on sale of non-marketable equity investments - - - - - - - - -159 334Other adjustments 2 -40 -32 -20 -12 6 -28 106 87 212Accounts receivable -624 -837 -334 -504 -1129 -1156 -787 -1307 -1641 -2094Income taxes, net 398 745 626 217 102 731 1492 401 283 -179Inventories - - - - - - 301 -234 - -Prepaid revenue share, expenses & other assets -289 -299 -147 262 -414 -262 -833 -696 459 -318Accounts payable 95 70 -212 34 272 101 -499 605 436 203Accrued expenses & other liabilities 292 419 339 243 745 795 762 713 757 1597Accrued revenue share 139 150 14 158 214 259 299 254 245 339Deferred revenue 31 70 41 76 111 162 163 233 -175 43

Net cash flows from operating activities 3581 5775 7853 9316 11081 14565 16619 18659 22376 26024

Investing ActivitiesPurchases of property & equipment -1903 -2403 -2358 -810 -4018 -3438 -3273 -7358 -10959 -9915Purchases of marketable securities -26682 -15997 -15356 -29139 -43985 -61672 -33410 -45444 -56310 -74368Maturities & sales of marketable securities 23107 15659 15763 22103 37099 48746 35180 38314 51315 62905Purchases of non-marketable investments -1019 -35 -47 -65 -320 -428 -696 -569 -1227 -2172Cash collateral related to (from) securities lending - - - - 2361 -354 -334 -299 1403 -350Investments in reverse repurchase agreements - - - - -750 5 45 600 -775 425Proceeds from divestiture of business - - - - - - 0 2525 386 0Acquisitions, net of cash acquired & proceeds received from divestiture, & purchases of intangible & other assets -402 -907 -3320 -108 -1067 -1900 -10568 -1448 -4888 -236

Net cash flows from investing activities -6899 -3682 -5319 -8019 -10680 -19041 -13056 -13679 -21055 -23711

Financing ActivitiesNet proceeds (payments) related to stock-based award activities 321 24 -72 143 294 -5 -287 -781 -2069 -2375Excess tax benefits from stock-based award activities 582 379 159 90 94 86 188 481 648 548Adjustment payment to class C capital stockholders - - - - - - - - - -47Repurchases of capital stock - - - - - - - - - -1780Repurchase of common stock in connection with acquisitions - - - - -801 - - - - -Proceeds from issuance of debt, net of costs - - - - - 10905 16109 10768 11625 13705Repayments of debt - - - - - -10179 -14781 -11325 -11643 -13728Proceeds from issuance of short-term debt - - - - 5246 - - - - -Repayment of short-term debt - - - - -1783 - - - - -Net proceeds from public offerings 2064 - - - - - - - - -

Net cash flows from financing activities 2966 403 88 233 3050 807 1229 -857 -1439 -3677Effect of exchange rate changes on cash & cash equivalents 20 40 -46 11 -19 22 3 -3 -433 -434Net increase (decrease) in cash & cash equivalents -333 2537 2575 1541 3432 -3647 4795 4120 -551 -1798Cash & cash equivalents at beginning of period 3877 3545 6082 8657 10198 13630 9983 14778 18898 18347Cash & cash equivalents at end of period 3545 6082 8657 10198 13630 9983 14778 18898 18347 16549

Alphabet Inc.Cash Flow Statement

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E CV 2021Operating ActivitesNet Income 19302 22655 26814 31969 38331 45847Depreciation and Amortization 5237 5687 6237 6901 7701 8661Stock Based Compensation 5466 6347 7418 8730 10347 12261Working Capital

Decrease (increase) in Accounts Receivable -1458 -2097 -2552 -3123 -3850 -4558Decrease (increase) in Inventories 0 0 0 0 0 0Decrease (increase) in Prepaid Revenue Share, Expenses, & Other Assets -592 -601 -731 -895 -1104 -1307Decrease (increase) in Income Taxes Receivable 214 -293 -364 -451 -557 -658Increase (decrease) in Accounts Payable 672 419 510 625 770 912Increase (decrease) in Accrued Compensation & Benefits 517 653 795 973 1200 1421Increase (decrease) in Accrued Expenses & Other Current Liabilities 438 839 1021 1249 1540 1823Increase (decrease) in Accrued Revenue Share -73 363 325 382 452 504Increase (decrease) in Income Taxes Payable 108 71 88 110 135 160Increase (decrease) in Deferred Revenue -51 119 145 177 218 258Decrease (increase) in Deferred Taxes -724 -126 -156 -193 -239 -282Increase (decrease) in Other Noncurrent Liabilities 607 1048 1292 1596 1148 1202

Net Cash Inflow (Outflow) from Operating Activities 29664 35084 40842 48048 56092 66245Investing ActivitiesDecrease (increase) in Marketable Securities -401 -404 -407 -410 -413 -416Capital Expenditures -8708 -9717 -10947 -12444 -14270 -16446Decrease (increase) in Receivables Under Repurchase Agreement -201 -105 -128 -156 -193 -228Increase in Securities Lending Payable -259 349 190 202 211 188Increase (decrease) in Other Assets -1874 -1650 -2007 -2457 -3029 -3586Business Acquisitions 0 0 0 0 0 0

Net Cash Inflow (Outflow) from Investing Activities -11442 -11526 -13299 -15265 -17694 -20487Financing ActivitiesProceeds (Payments) Related to Long-Term Debt 1943 0 0 0 -1000 0Proceeds (Payments) Related to Short-Term Debt -3225 1000 0 0 1000 0Proceeds from Issuance of Common Stock -3710 -4353 -5175 -6374 -7555 -8953Repurchase of Common Stock -3750 -5000 0 0 0 0Change in Accumulated Other Comprehensive Income 0 0 0 0 0 0

Net Cash Inflow (Outflow) from Financing Activities -8742 -8353 -5175 -6374 -7555 -8953Net Change in Cash 9479 15205 22367 26409 30843 36805Beginning Cash Balance 16549 26028 41234 63601 90010 120853End Cash Balance 26028 41234 63601 90010 120853 157658

Alphabet Inc.Common Size Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Cost of revenues 32.52% 31.38% 30.81% 31.50% 31.50% 31.50% 31.50% 31.50% 31.50%Depreciation & Amortization Expense 7.09% 7.54% 6.75% 6.04% 5.65% 5.30% 4.98% 4.69% 4.45%Gross Profit 60.39% 61.07% 62.44% 62.46% 62.85% 63.20% 63.52% 63.81% 64.05%

Research & development expenses 12.86% 14.90% 16.38% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00%Sales & marketing expenses 11.80% 12.32% 12.06% 12.00% 12.00% 12.00% 12.00% 12.00% 12.00%General & administrative expenses 7.98% 8.87% 8.18% 8.50% 8.50% 8.50% 8.50% 8.50% 8.50%Charge related to the resolution of Department of Justice investigation 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Total costs & expenses 72.26% 75.01% 74.18% 73.04% 72.65% 72.30% 71.98% 71.69% 71.45%Income from operations 27.74% 24.99% 25.82% 26.96% 27.35% 27.70% 28.02% 28.31% 28.55%

Interest Income 1.38% 1.13% 1.33% 0.98% 0.82% 0.84% 0.88% 0.90% 0.92%Interest Expense 0.15% 0.15% 0.14% 0.18% 0.12% 0.13% 0.11% 0.09% 0.08%Other Income -0.34% 0.18% -0.81% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05%Impairment of equity investments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Income before income taxes 28.64% 26.15% 26.21% 27.81% 28.11% 28.46% 28.84% 29.17% 29.45%Provision for income taxes 4.93% 5.51% 4.40% 5.56% 5.62% 5.69% 5.77% 5.83% 5.89%Net income from continuing operations 23.70% 20.64% 21.80% 22.25% 22.49% 22.77% 23.07% 23.34% 23.56%Net income (loss) from discontinued operations -0.77% 0.78% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Net income 22.93% 21.42% 21.80% 22.25% 22.49% 22.77% 23.07% 23.34% 23.56%

Alphabet Inc.Common Size Balance Sheet (% Assets)


Cash & cash equivalents 17.04% 13.99% 11.24% 15.76% 21.74% 28.50% 34.26% 39.04% 43.17%Marketable securities 35.90% 35.12% 38.39% 34.46% 30.22% 25.87% 22.13% 18.91% 16.15%Total cash, cash equivalents, & marketable securities 52.94% 49.11% 49.63% 50.21% 51.95% 54.38% 56.38% 57.95% 59.32%Accounts receivable, net 8.01% 7.16% 7.85% 7.88% 7.97% 7.92% 7.91% 7.96% 7.99%Inventories 0.38% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Receivable under reverse repurchase agreements 0.09% 0.67% 0.31% 0.39% 0.40% 0.40% 0.40% 0.40% 0.40%Deferred income taxes, net 1.38% 1.01% 0.00% 0.44% 0.45% 0.45% 0.46% 0.46% 0.47%Income taxes receivable, net 0.37% 0.99% 1.29% 1.02% 1.04% 1.05% 1.06% 1.08% 1.10%Prepaid revenue share, expenses & other assets 2.55% 2.60% 2.13% 2.26% 2.28% 2.27% 2.27% 2.28% 2.29%

Total current assets 65.71% 61.53% 61.21% 62.20% 64.09% 66.46% 68.48% 70.14% 71.57%Prepaid revenue share, expenses & other assets, non-current 1.78% 2.50% 2.16% 2.26% 2.28% 2.27% 2.27% 2.28% 2.29%Non-marketable investments 1.78% 2.35% 3.52% 3.94% 3.98% 3.96% 3.96% 3.98% 4.00%Deferred income taxes 0.00% 0.00% 0.17% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Property & equipment, gross 21.49% 24.97% 27.27% 29.57% 30.87% 31.16% 31.19% 31.09% 30.85%Less: accumulated depreciation & amortization 6.59% 6.76% 7.56% 9.37% 10.80% 11.74% 12.44% 12.95% 13.28%Property & equipment, net 14.90% 18.21% 19.71% 20.20% 20.07% 19.41% 18.75% 18.14% 17.57%Intangible assets, net 5.47% 3.51% 2.61% 1.79% 1.20% 0.79% 0.51% 0.34% 0.22%Goodwill 10.36% 11.90% 10.78% 9.61% 8.37% 7.11% 6.04% 5.13% 4.35%Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%


Accounts payable 2.21% 1.31% 1.31% 1.58% 1.59% 1.58% 1.58% 1.59% 1.60%Short-term debt 2.71% 1.53% 2.19% 0.00% 0.53% 0.45% 0.38% 0.65% 0.55%Accrued compensation & benefits 2.26% 2.34% 2.40% 2.46% 2.48% 2.47% 2.47% 2.48% 2.49%Accrued expenses & other current liabilities 3.39% 3.38% 3.24% 3.15% 3.19% 3.17% 3.16% 3.18% 3.20%Accrued revenue share 1.56% 1.49% 1.58% 1.37% 1.38% 1.32% 1.27% 1.22% 1.17%Securities lending payable 1.24% 2.12% 1.65% 1.31% 1.33% 1.21% 1.11% 1.01% 0.91%Deferred revenue 0.96% 0.57% 0.54% 0.45% 0.45% 0.45% 0.45% 0.45% 0.45%Income taxes payable, net 0.02% 0.07% 0.21% 0.25% 0.25% 0.26% 0.26% 0.26% 0.27%

Total current liabilities 14.34% 12.82% 13.12% 10.56% 11.20% 10.90% 10.67% 10.84% 10.63%Long-term debt 2.02% 2.46% 1.36% 2.38% 2.08% 1.76% 1.50% 0.95% 0.80%Deferred revenue, non-current 0.13% 0.08% 0.10% 0.18% 0.19% 0.18% 0.18% 0.19% 0.19%Income taxes payable, net, non-current 2.38% 2.60% 2.49% 2.48% 2.54% 2.55% 2.59% 2.63% 2.67%Deferred income taxes 1.76% 1.50% 0.13% 0.02% 0.03% 0.03% 0.03% 0.03% 0.03%Other long-term liabilities 0.67% 0.85% 1.24% 1.05% 1.06% 1.06% 1.05% 0.80% 0.53%Class A & class B common stock & additional paid-in capital 23.37% 21.94% 22.40% 21.03% 19.36% 17.47% 15.73% 14.25% 12.99%Accumulated other comprehensive income (loss) 0.11% 0.02% -1.27% -1.13% -0.99% -0.84% -0.71% -0.61% -0.51%Retained earnings 55.23% 57.73% 60.61% 63.43% 64.54% 66.89% 68.96% 70.92% 72.67%Total stockholders' equity 78.71% 79.69% 81.74% 83.32% 82.91% 83.51% 83.98% 84.57% 85.15%Total liabilities and stockholders' equtiy 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Alphabet Inc.Common Size Balance Sheet (% Sales)


Cash & cash equivalents 34.04% 27.80% 22.07% 30.00% 40.93% 54.01% 64.96% 73.58% 81.01%Marketable securities 71.72% 69.77% 75.37% 65.60% 56.90% 49.03% 41.96% 35.65% 30.30%Total cash, cash equivalents, & marketable securities 105.76% 97.57% 97.44% 95.61% 97.83% 103.04% 106.91% 109.23% 111.30%Accounts receivable, net 16.00% 14.22% 15.41% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00%Inventories 0.77% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Receivable under reverse repurchase agreements 0.18% 1.33% 0.60% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75%Deferred income taxes, net 2.75% 2.00% 0.00% 0.83% 0.84% 0.85% 0.87% 0.88% 0.88%Income taxes receivable, net 0.73% 1.97% 2.54% 1.95% 1.97% 1.99% 2.02% 2.04% 2.06%Prepaid revenue share, expenses & other assets 5.09% 5.17% 4.19% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%

Total current assets 131.28% 122.25% 120.17% 118.44% 120.69% 125.94% 129.85% 132.20% 134.30%Prepaid revenue share, expenses & other assets, non-current 3.56% 4.97% 4.24% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%Non-marketable investments 3.56% 4.67% 6.91% 7.50% 7.50% 7.50% 7.50% 7.50% 7.50%Deferred income taxes 0.00% 0.00% 0.33% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Property & equipment, gross 42.93% 49.61% 53.54% 56.31% 58.14% 59.04% 59.15% 58.59% 57.89%Less: accumulated depreciation & amortization 13.17% 13.43% 14.84% 17.85% 20.34% 22.25% 23.60% 24.41% 24.92%Property & equipment, net 29.76% 36.19% 38.69% 38.46% 37.80% 36.79% 35.55% 34.18% 32.97%Intangible assets, net 10.93% 6.98% 5.13% 3.41% 2.26% 1.49% 0.98% 0.63% 0.41%Goodwill 20.70% 23.63% 21.16% 18.29% 15.75% 13.48% 11.45% 9.66% 8.15%Total assets 199.79% 198.68% 196.31% 190.41% 188.31% 189.49% 189.63% 188.48% 187.63%


Accounts payable 4.42% 2.60% 2.58% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00%Short-term debt 5.42% 3.04% 4.30% 0.00% 0.99% 0.85% 0.72% 1.22% 1.03%Accrued compensation & benefits 4.51% 4.65% 4.72% 4.67% 4.67% 4.67% 4.67% 4.67% 4.67%Accrued expenses & other current liabilities 6.76% 6.72% 6.36% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00%Accrued revenue share 3.11% 2.96% 3.11% 2.60% 2.60% 2.50% 2.40% 2.30% 2.20%Securities lending payable 2.47% 4.21% 3.24% 2.50% 2.50% 2.30% 2.10% 1.90% 1.70%Deferred revenue 1.91% 1.14% 1.05% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85%Income taxes payable, net 0.04% 0.15% 0.40% 0.47% 0.48% 0.48% 0.49% 0.50% 0.50%

Total current liabilities 28.65% 25.46% 25.75% 20.10% 21.10% 20.66% 20.24% 20.44% 19.95%Long-term debt 4.03% 4.89% 2.66% 4.54% 3.91% 3.34% 2.84% 1.79% 1.51%Deferred revenue, non-current 0.25% 0.16% 0.20% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35%Income taxes payable, net, non-current 4.75% 5.16% 4.88% 4.73% 4.78% 4.84% 4.90% 4.96% 5.01%Deferred income taxes 3.51% 2.99% 0.25% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05%Other long-term liabilities 1.34% 1.69% 2.43% 2.00% 2.00% 2.00% 2.00% 1.50% 1.00%Class A & class B common stock & additional paid-in capital 46.69% 43.59% 43.98% 40.04% 36.46% 33.10% 29.83% 26.86% 24.37%Accumulated other comprehensive income (loss) 0.23% 0.04% -2.50% -2.16% -1.86% -1.59% -1.35% -1.14% -0.96%Retained earnings 110.34% 114.70% 118.98% 120.77% 121.53% 126.75% 130.77% 133.67% 136.36%Total stockholders' equity 157.26% 158.33% 160.46% 158.64% 156.13% 158.25% 159.25% 159.40% 159.77%Total liabilities and stockholders' equtiy 199.79% 198.68% 196.31% 190.41% 188.31% 189.49% 189.63% 188.48% 187.63%

Alphabet Inc.Weighted Average Cost of Capital (WACC) Estimation

Cost of Equity CalculationRisk-free rate 2.99%Risk premium 6.26%Beta 1.063

Cost of Equity 9.64%

Cost of Debt 3.77%

Cost of Preferred Stock 0.00%

Capital Structure WeightsEquity

Shares Outstanding 631Share Price $772.35

MV Equity 487,713Debt

Short Term Debt 3225Long Term Debt 1995PV ofOperating Leases 6063

MV Debt 11283Preferred

Shares Outstanding 0Share Price 0

MV Preferred 0MV Weight of Equity 97.74%MV Weight of Debt 2.26%MV Weight of Preferred 0.00%WACC 9.49%

Alphabet Inc.Value Driver Estimation

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021

Marginal Tax Rate CalculationFederal 35.00% 35.00% 35.00%State 0.84% 0.76% -1.48%Foreign -15.61% -12.22% -13.35%

Marginal Tax Rate 20.23% 23.55% 20.17% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00%

NOPLAT calculationEBITA CalculationRevenues 55519 66001 74989 86759 100739 117750 138569 164239 194626

Less: Cost of revenues 18054 20712 23101 27329 31733 37091 43649 51735 61307Less: Research & development expenses 7137 9832 12282 13014 15111 17663 20785 24636 29194Less: Sales & marketing expenses, net implied operating lease interest 6554 8131 9047 10412 12089 14131 16629 19710 23357Plus: Implied Interest on PV Leases 126 190 229 393 570 768 992 1251 1554Less: General & administrative expenses 4432 5851 6136 7374 8562 10008 11777 13959 16542

EBITA 19468 21665 24652 29023 33814 39625 46720 55450 65780

Income Tax Provision 2739 3639 3303 4826 5664 6703 7992 9583 11462Plus: Tax Shield on Interest Expense 16 24 21 39 30 37 37 37 37Less: Tax on Interest Income 155 176 201 212 207 246 303 370 449Less: Tax on Non-Operating Income -38 28 -122 11 13 15 17 21 24Plus: Tax Shield from Lease Interest 26 45 46 98 143 192 248 313 388Plus: Tax Shield from Justice Department Ruling 0 0 0 0 0 0 0 0 0Plus: Tax Shield from Impariment of Equity Investments 0 0 0 0 0 0 0 0 0

Adjusted Taxes 2664 3504 3290 4740 5616 6671 7957 9542 11414

Change in Deferred Taxes 307 -228 711 621 119 147 182 225 266

NOPLAT 17111 17933 22072 24904 28317 33101 38946 46133 54632

Invested Capital CalculationNet Operating Working CapitalOperating Current Assets

Normal Cash 1110 1320 1500 1735 2015 2355 2771 3285 3893Accounts receivable 8882 9383 11556 13014 15111 17663 20785 24636 29194Inventory 426 0 0 0 0 0 0 0 0Income taxes receivable, net 408 1298 1903 1689 1982 2346 2797 3354 4012Prepaid revenue share, expenses & other assets 2827 3412 3139 3731 4332 5063 5958 7062 8369

Total Operating Current Assets 13653 15413 18098 20169 23440 27427 32312 38337 45467Operating Current Liabilities

Accounts payable 2453 1715 1931 2603 3022 3533 4157 4927 5839Accrued expenses 7986 9455 10636 11517 13373 15513 18117 21309 25057Deferred revenue 1062 752 788 737 856 1001 1178 1396 1654Income taxes payable 24 96 302 410 481 570 679 815 974

Total Operating Current Liabilities 11525 12018 13657 15267 17733 20616 24132 28447 33525Total Net Operating Working Capital 2128 3395 4441 4901 5707 6811 8181 9890 11942Plus: Net PPE 16524 23883 29016 33371 38082 43317 49263 56144 64168Plus: Other Operating Assets

Net Intangible Assets (non-goodwill) 6066 4607 3847 2962 2281 1756 1352 1041 802Capitalized PV of Operating Leases 3352 5045 6063 10418 15129 20364 26310 33191 41215Prepaid revenue share, expenses & other assets, non-current 1976 3280 3181 3731 4332 5063 5958 7062 8369

Total Other Operating Assets 11394 12932 13091 17111 21742 27183 33621 41294 50386Less: Other Operating Liabilities

Deferred revenue, non-current 139 104 151 304 353 412 485 575 681Other operating liabilities 743 1118 1822 1735 2015 2355 2771 2464 1946

Total Other Operating Liabilities 882 1222 1973 2039 2367 2767 3256 3038 2627Invested Capital 29165 38988 44575 53345 63163 74543 87809 104290 123870

Value DriversROIC Calculation

NOPLAT 17111 17933 22072 24904 28317 33101 38946 46133 54632Beginning Invested Capital 24925 29165 38988 44575 53345 63163 74543 87809 104290

ROIC 68.65% 61.49% 56.61% 55.87% 53.08% 52.41% 52.25% 52.54% 52.38%

FCF CalculationNOPLAT 17111 17933 22072 24904 28317 33101 38946 46133 54632Change in Invested Capital 4240 9824 5587 8770 9819 11380 13266 16481 19580

FCF 12871 8110 16485 16134 18498 21721 25680 29653 35052

EP CalculationBeginning Invested Capital 24925 29165 38988 44575 53345 63163 74543 87809 104290ROIC 68.65% 61.49% 56.61% 55.87% 53.08% 52.41% 52.25% 52.54% 52.38%WACC 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%

EP 14619 15017 18173 20447 22982 26785 31491 37353 44203

Alphabet Inc.Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth of NOPLAT 2.00% CV ROIC 55.00% WACC 9.49% Cost of Equity 9.64%

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E CV 2021

DCF ModelNOPLAT 24904 28317 33101 38946 46133 54632Beginning Invested Capital 44575 53345 63163 74543 87809 104290Ending Invested Capital 53345 63163 74543 87809 104290 123870

Change in Invested Capital 8770 9819 11380 13266 16481 19580Free Cash Flow 16134 18498 21721 25680 29653 35052ROIC 55.87% 53.08% 52.41% 52.25% 52.54% 52.38%CV 702853.08CF to Discount 16134 18498 21721 25680 29653 702853Periods to Discount 1 2 3 4 5 5PV 14736 15430 16549 17869 18845 446671Value of Operating Assets 530099

Plus: Excess Cash 15049Plus: Marketable Securities 56517Plus: Receivable Under Repurchase 450Less: Total Debt 5220Less: Securities Lending Payable 2428Less: PV of Operating Leases 6063Less: PV of ESOP 2854Value of Equity 585550Shares Outstanding 685Intrinsic Value of Stock 854.82

EP ModelNOPLAT 24904 28317 33101 38946 46133 54632Beginning Invested Capital 44575 53345 63163 74543 87809 104290ROIC 55.87% 53.08% 52.41% 52.25% 52.54% 52.38%EP 20674 23254 27107 31871 37800 44735CV 598563.33

Discounting:Beginning IC 44575EP 20674 23254 27107 31871 37800 598563Periods to Discount 1 2 3 4 5 5PV of EP 18882 19398 20652 22177 24022 380393

Value of Operating Assets 530099Plus: Excess Cash 15049Plus: Marketable Securities 56517Plus: Receivable Under Repurchase 450Less: Total Debt 5220Less: Securities Lending Payable 2428Less: PV of Operating Leases 6063Less: PV of ESOP 2854Value of Equity 585550Shares Outstanding 685Intrinsic Value of Stock 854.82

Today 11/15/2016Next FYE 12/31/2016Last FYE 12/31/2015Days in FY 366 Days to FYE 320 Elapsed Fraction 0.874Adjusted Stock Price 926.48

Alphabet Inc.Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E CV 2021

EPS 28.32$ 33.47$ 39.55$ 47.15$ 56.53$ 67.62$

Key Assumptions CV growth of EPS 2.00% CV ROE 16.01% Cost of Equity 9.64%

Retention Ratio 12.49%

Future Cash Flows P/E Multiple (CV Year) 11.45 EPS (CV Year) 67.62$ Future Stock Price 774.05$ Dividends Per Share 24.79$ 29.29$ 34.61$ 41.26$ 49.47$ 59.17$ Discount Periods 1 2 3 4 5 5 Future Cash Flows 22.61$ 24.36$ 26.25$ 28.55$ 31.22$ 37.34$

488.47$ Discounted Cash Flows 22.61$ 24.36$ 26.25$ 28.55$ 31.22$ 525.81$

Intrinsic Value 658.80$ Adjusted Stock Price 714.02$

Alphabet Inc.Relative Valuation Model

EPS EPSTicker Company Price 2016E 2017E P/E 16 P/E 17YHOO Yahoo, Inc. $39.90 $0.58 $0.62 68.8 64.4 BIDU Baidu, Inc. $165.73 $4.28 $5.72 38.7 29.0 MSFT Microsoft Corporation $59.04 $2.97 $3.24 19.9 18.2 AMZN Amazon.com, Inc. $737.37 $4.75 $8.99 155.2 82.0 FB Facebook $117.14 $4.07 $5.19 28.8 22.6

Average 62.3 43.2

GOOGL Alphabet Inc. $772.35 $28.32 $33.47 27.3 23.1

Implied Value: Relative P/E (EPS16) $ 1,764.10 Relative P/E (EPS17) 1,446.82$

Alphabet Inc.Key Management Ratios

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021

Liquidity RatiosCurrent Ratio CA/CL 4.58 4.80 4.67 5.89 5.72 6.10 6.42 6.47 6.73Quick Ratio (CA - Inventory)/CL 4.55 4.80 4.67 5.89 5.72 6.10 6.42 6.47 6.73Cash Ratio (Cash + Mkt Sec)/CL 3.69 3.83 3.78 4.76 4.64 4.99 5.28 5.34 5.58

Activity or Asset-Management RatiosReceivables Turnover Sales/Avg Accts Rec 6.62 7.23 7.16 7.06 7.16 7.19 7.21 7.23 7.23Total Asset Turnover Sales/Avg Total Assets 0.49 0.46 0.47 0.48 0.49 0.49 0.48 0.48 0.49

Financial Leverage RatiosDebt to Equity Ratio Total Debt/Shareholders' Equity 0.06 0.05 0.04 0.03 0.03 0.03 0.02 0.02 0.02Debt Ratio Total Liabilities/Total Assets 0.21 0.20 0.18 0.17 0.17 0.16 0.16 0.15 0.15Interest Coverage Ratio Operating Income/Interest Expense 190.16 163.33 186.15 149.38 233.26 220.20 262.09 313.88 375.09

Profitability RatiosReturn on Equity Net Income/Avg Shareholders' Equity 16.01% 14.74% 14.54% 14.96% 15.36% 15.61% 15.71% 15.89% 16.01%Return on Assets Net Income/Avg Total Assets 12.44% 11.68% 11.75% 12.36% 12.77% 12.99% 13.16% 13.39% 13.59%Cash Flow Margin Operating Cash Flow/Net Income 154.78% 146.54% 158.29% 153.68% 154.87% 152.32% 150.30% 146.34% 144.49%

Payout Policy RatiosPayout Ratio Dividends Per Share/EPS 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Dividend Payout Ratio EPS/Dividends Per Share N/A N/A N/A N/A N/A N/A N/A N/A N/A

926.48 21.00% 22.00% 23.00% 24.00% 25.00% 926.48 0.86 0.96 1.06 1.16 1.26-11.00% 881.35 890.22 899.40 908.89 918.73 5.26% 1279.66 1168.42 1075.17 995.93 927.80-10.00% 893.48 902.88 912.61 922.69 933.13 5.76% 1186.94 1082.47 995.16 921.17 857.69

Cost-per-click Growth -9.00% 906.19 916.15 926.48 937.17 948.26 Risk Premium 6.26% 1106.88 1008.49 926.48 857.13 797.78-8.00% 919.52 930.08 941.03 952.38 964.16 6.76% 1037.09 944.17 866.90 801.71 746.02-7.00% 933.49 944.68 956.30 968.35 980.86 7.26% 975.74 887.76 814.77 753.31 700.91

926.48 30.50% 31.00% 31.50% 32.00% 32.50% 926.48 23.00% 24.00% 25.00% 26.00% 27.00%19.50% 977.96 964.96 951.97 938.98 925.98 2.49% 989.22 989.40 989.59 989.77 989.9620.00% 965.21 952.22 939.22 926.23 913.24 2.74% 956.59 956.75 956.92 957.09 957.2520.50% 952.46 939.47 926.48 913.48 900.49 2.99% 926.18 926.33 926.48 926.62 926.7721.00% 939.72 926.72 913.73 900.74 887.74 3.24% 897.78 897.91 898.04 898.17 898.3021.50% 926.97 913.98 900.98 887.99 875.00 3.49% 871.19 871.31 871.42 871.54 871.65

926.48 54.00% 54.50% 55.00% 55.50% 56.00%1.00% 854.78 854.89 855.00 855.11 855.211.50% 888.15 888.33 888.50 888.67 888.84

CV NOPLAT 2.00% 925.98 926.23 926.48 926.72 926.952.50% 969.22 969.56 969.88 970.21 970.523.00% 1019.12 1019.56 1019.98 1020.40 1020.80

Beta

Marginal Tax Rate

CV ROIC

Paid Clicks Growth

SG&A (% Sales)

COGS (% Sales)

Risk Free Rate

Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013)

Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Leases2016 646 2015 598 2014 4992017 781 2016 622 2015 4772018 792 2017 634 2016 4382019 766 2018 596 2017 4182020 716 2019 576 2018 370Thereafter 3705 Thereafter 3157 Thereafter 1836Total Minimum Payments 7406 Total Minimum Payments 6183 Total Minimum Payments 4038Less: Interest 1343 Less: Interest 1138 Less: Interest 686PV of Minimum Payments 6063 PV of Minimum Payments 5045 PV of Minimum Payments 3352

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 3.77% Pre-Tax Cost of Debt 3.77% Pre-Tax Cost of Debt 3.77%Number Years Implied by Year 6 Payment 5.2 Number Years Implied by Year 6 Payment 5.5 Number Years Implied by Year 6 Payment 5.0

Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment1 646 622.5 1 598 576.3 1 499 480.92 781 725.3 2 622 577.6 2 477 443.03 792 708.8 3 634 567.4 3 438 392.04 766 660.6 4 596 514.0 4 418 360.55 716 595.1 5 576 478.7 5 370 307.56 & beyond 716 2750.7 6 & beyond 576 2331.1 6 & beyond 370 1368.3PV of Minimum Payments 6063.0 PV of Minimum Payments 5045.0 PV of Minimum Payments 3352.1

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding(in millions)Number of Options Outstanding (shares): 5Average Time to Maturity (years): 3.70Expected Annual Number of Options Exercised: 1

Current Average Strike Price: 212.02$ Cost of Equity: 9.64%Current Stock Price: $772.35

2016E 2017E 2018E 2019E 2020E CV 2021Increase in Shares Outstanding: 1 1 1 0 0 0Average Strike Price: 212.02$ 212.02$ 212.02$ 212.02$ 212.02$ 212.02$ Increase in Common Stock Account: 281 281 241 - - -

Change in Treasury Stock 3,750 5,000 - - - - Expected Price of Repurchased Shares: 772.35$ 846.84$ 928.51$ 1,018.06$ 1,116.24$ 1,223.90$ Number of Shares Repurchased: 5 6 - - - -

Shares Outstanding (beginning of the year) 685 681 677 678 678 678Plus: Shares Issued Through ESOP 1 1 1 0 0 0Less: Shares Repurchased in Treasury 5 6 - - - - Shares Outstanding (end of the year) 681 677 678 678 678 678

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol GOOGLCurrent Stock Price $772.35Risk Free Rate 2.99%Current Dividend Yield 0.00%Annualized St. Dev. of Stock Returns 20.26%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedEmployee Stock Options 4,898,983 212.02 3.70 582.54$ 2,853,844,149$ Total 4,898,983 212.02$ 3.70 582.54$ 2,853,844,149$

ALPHABET, INC. (NASDAQ: GOOGL) · Share Highlights Market Capitalization $510.77B . Shares...

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Transcript of ALPHABET, INC. (NASDAQ: GOOGL) · Share Highlights Market Capitalization $510.77B . Shares...