GOOGL Stock Forecast: CAPEX Tripled – Is Chelsea Market worth $2.4 billion?

  The article was written by Hieu Nguyen, a Financial Analyst at I Know First.

GOOGL Stock Forecast

“Our commitment to growth is evident in the trend in capex investment, almost equally split this quarter between compute capacity and facilities. Our facilities spend in Google, dominated by the Chelsea Market acquisition, reflects that we favor owning rather than leasing real estate when we see good opportunities” – Ruth Porat, CFO Alphabet and Google

Summary:

    • Alphabet Q1 2018 result beat market expectation, mainly due to the change in accounting principle.
    • Chelsea Market deal and increasing costs in data centers and other facilities bumped the CAPEX up to $7.7 billion.
    • The battle against EU’s antitrust law may cost Alphabet $11 billion, wiping off 85% of its 2017 net income
    • My DCF Model and I Know First Algorithm both agree on a hold recommendation for GOOGL.

(Source: Wikimedia Commons)

Supported By Uber Investment, Apple Bottom Line Jumped Up By 73%

On April 23, Alphabet (NASDAQ: GOOGL), the parent company of Google, has announced the Q1 2018 result. While the revenue grew 26% year over year, the EPS also jumped up 72% from $7.73 to $13.33.

The investment in Uber is one of the main factors that contributed for the significant increase of EPS. Earlier in 2013, Alphabet made $258 million investment in Uber at the market value of $3.8 billion. Uber is now worth more than $60 billion. Also, the ASU 2016-01 that the company adopted from January 1, 2018 has changed the way it recognizes marketable equity securities. Alphabet will now recognize the investment in Uber at it current market value. Moreover, Alphabet is also benefited from the lawsuit between Uber and Waymo, Alphabet’s self-driving car. In this lawsuit, Uber has agreed to pay Waymo 0.34% of a late stock offering that equals to $245 million. However, these incomes are considered one time earning so it will not have long-term impact on the company.

Google’s Core Business is still expanding despite of strong competition

Besides that, the core business model of Alphabet is still witnessing a double-digit growth rate. The advertising revenues increased by 24.4% thanks to the both the Google properties and Google Network Members’s properties revenues. For Google properties, the cost per for decreased by 19% but and remained the same for Google Network Members’ properties. However, the decline was completely offset by the increase in number of clicks, 59%. On the other hand, the cost-per-impression of Google Network Members’ properties also increased by 18%.

Unlike the revenue, the gross profit margin has continued its decreasing trend. The gross profit margin dropped 366 basis points from to 60.42% to 56.76% year over year. The continuing downward pressure for the margin mainly comes from the increasing competition and costs for different business aspects. Although, Google is the market leader in search engine industry, it is facing with more competitors now including Amazon and Facebook. Despite these two companies do not provide search engines, their business model relies on customers’ database. “They are obviously more focused on the commerce side of the equation, but, at their roots, they are answering users’ questions and searches, just as we are.” Eric Schmidt, Google’s executive chairman. Also, the inclining contribution of other revenues including mobile, other device mixes, and new businesses also lowers the gross margin.

Capital Expenditure Tripled Due To Chelsea Market

The capital expenditure of Google has tripled in Q1 2018 compared to Q1 2017, mainly due to the acquisition of Chelsea Market. Earlier in March 2018, Alphabet has confirmed its purchased for Chelsea Market in Mahattan for $2.4 billion. According Ruth Porat, the CFO of Alphabet, and Google, the deal is a proof for the growth commitment of the company. He said in the conference call “Our facilities spend in Google, dominated by the Chelsea Market acquisition, reflects that we favor owning rather than leasing real estate when we see good opportunities”.

Despite of the potential of the location of Chelsea Market, this deal is still a huge question mark for Alphabet’s stockholder. Alphabet has not announced its plan on the Chelsea Market. Moreover, as there is increasing competitiveness in the technology world, there could be a huge need for hardware investment. As a result, it may not be a good timing to invest in Chelsea Market now. Other drivers are the data centers and other facilities. Currently, Google is having 20 data centers under construction all over the world.

(Source: Wikimedia Commons)

EU antitrust penalty against Google: A Never-Ending War

During June 2018, Alphabet may have to face with the third antitrust penalty from EU related to the Android case. The penalty may cost Alphabet up to $11 billion, more than 85% of the 2017 net income.

Earlier in June 2017, European Commission has also announced a fine of €2.42 billion ($2.85 billion) on Google. Margrethe Vestager, the European commissioner, accused Google of abusing its market dominance by providing unfair advantage to its another product. Later that day, Google decreased by 2.5%, closing at 948.09. However, the fine doesn’t change the business model of the company.

As a result, the European Commission decided the conduct the third investigation on Google Android system. As Android possesses more than 80% market share of the global smartphone operating system, Google is suspected of banning other competitors from websites that used its search bar and advertisements. If the penalty is finalized, it can be a big hit on the financial result of Alphabet.

Stock seems to be overvalued based on DCF Model

Following several concerns about Alphabet, the price of the company also seems to be overvalued. I have performed a 5-year DCF analysis on the company. The DCF model derived a target price of $187 for the company. DCF model was constructed based on 3 main factors: top line and bottom line forecast, capital expediture, and discount rate.

 

Current I Know First Forecast for GOOGL:

My recommendation is supported by the forecast of I Know First. On June 10th, 2018, I Know First issued a forecast for Google with the three-month signal of 18.18 and predictability of 0.13. The 1-year signal for Alphabet is even lower at 11.52. The prediction totally agrees with the above arguments about the future of Alphabet.

Conclusion

Alphabet still remains as one of the biggest corporations in the technology industry. The company still expands its core business model both in quantity and quality. The Q1 2018 result beat the market expectation mainly because of the change in accounting principle. However, lately, Alphabet has faced with several concerns related to its Chelsea Market purchase as well as the antitrust penalty on the company in Europe. As a result, we issued a Hold recommendation on Alphabet stock.

Go here to read how to interpret this diagram.

Past I Know First Forecast Success with GOOGL:

On June 23,2017, I Know First published a premium article saying that it’s time to go long for Google’s stock . I Know First has been bullish on Google’s stock all of the 3 time horizons. We suggested to buy the stock based on the prediction signal as well as the fundamental analysis. From the below graph one can see that the I Know First algorithm successfully predicted the movement of the GOOGL stock price which grew by 15.70% over almost a year.

Current I Know First subscribers received this bullish FL  forecast on June 23, 2017.

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