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Analysts

Ryan Crockett ryan-crockett@uiowa.edu

Nicholas Payne nick-payne@uiowa.edu

Maxwell Neumann maxwell-neumann@uiowa.edu

Trevor Heimke trevor-heimke@uiowa.edu

Company Overview Alphabet Inc. (GOOGL) is the contemporary goliath of innovation and advertising powerhouse of the Internet Software & Services industry. It was founded in 1998, headquartered in Mountain View, California. Originally providing just a search engine, Alphabet now holds 8 distinct subsidiaries specializing from anti-aging research labs to self-driving cars. As a company, they focus mainly on cultivating creativity and solving large problems. Implementing a “what if” attitude has allowed Alphabet to become the second largest publicly traded company in the world with an attractive future. Stock Performance Highlights 52 week High $810.35 52 week Low $529 Beta Value 0.908 Average Daily Volume 2.48 m Share Highlights Market Capitalization $531.32b Shares Outstanding 1.77 b Book Value per share $175.07 EPS $23.59 P/E Ratio 32.72 Dividend Yield 0.0% Dividend Payout Ratio 0.0% Company Performance Highlights ROA 11.74% ROE 14.54% Sales $73,590b Financial Ratios Current Ratio 4.67 Debt to Equity 4.34%

One Year Stock Performance

Continuing to Find Innovation in Desolation

Google advertising revenues will continue to expand with the economy at a stable pace. Costs of Revenues will simultaneously increase at a decelerating rate with system innovation. Revenues coming from sources other than advertising (Google Other Revenues) will start to make up a more significant percentage of total revenues. Expect Research & Development costs to continue to climb as Alphabet extends into research intensive ventures. Production of driverless cars will require Alphabet to greatly increase their capital expenditures or will involve rapid expansion with more operating lease expenses. Anticipate a large surge within the next three fiscal years. Liquidation/ Sale of Yahoo will prove beneficial for Google revenues as they pick up the deterred market share in the next fiscal year.

Nest & Other hardware sells will begin to show more promise as workforce restructuring reinvigorates product line. Previous sales failed to make an impact on overall revenues, future performance will not reflect on past numbers.

Alphabet Inc. (NASDAQ: GOOGL) Current Price: $751.72 Target Price: $843.94

Technology Krause Fund Research | Spring 2016

Recommendation: BUY April 13, 2016

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Executive Summary For Alphabet Inc. our team of analysts suggests a BUY rating. The current share price is trading at $751.72 but we believe this is below the true intrinsic value of the stock. The Discounted Cash Flow and Economic Profit valuations yielded the most accurate forecasted share price at $843.94. This price was then adjusted to reflect partial year expired. Other valuations such as the Dividend Discount Model and the Relative Valuations yielded values below current day trading prices and we believe they should not be used when issuing a decision. We believe these models should be discredited because Alphabet Inc. is drastically different than any other company that currently exists. Since the DDM uses industry average metrics and the Relative Valuation is compared to other similar companies, it is hard to trust the accuracy of these results. Furthermore, we expect Alphabet to continue developing and producing new technology that will have large initial costs but will create new long-term sources of revenue.

Economic Outlook

Real Gross Domestic Product

Real Gross Domestic Product for the United States experienced an increase at an annualized rate of 2.4 percent in 2015 after the third revised estimate. After these revisions, we have increased at the same rate as 2014.1This increase signals a healthy economy, but plateauing from the previous year hints at near future uncertainty and should be handled with caution. Revenues brought in from Google are heavily reliant on advertising. As a top company in the massive online advertising industry, GDP growth is a fair indicator of the direction Google trends. Corporate profits decreased by 159.6 billion in Q4 of 2015, compared to

a 33 billion decrease in Q3 of the same year.2 Alphabet still managed to have an impressive growth despite the large downfall in corporate profits.

The Personal Consumption Expenditures index slowed down to a 1.1 Q4 increase in comparison to an increase of 2.2 percent in the previous quarter.3 The deceleration in PCE is likely heavily contributed to the slowdown of GDP growth. PCE is necessary to monitor for the rough estimates of disposable income of consumers. According to the Federal Reserve, PCE inflation is expected to rise significantly in 2016. This is most likely attributable to the plans to gradually increase interest rates and the proposed inflation target of 2%. 4

Another factor which could drastically effect the Real GDP is the impact of the presidential candidacy. The Treasury Department in April of 2016 implemented tighter restrictions on corporate taxation rules. Details in this imposed change mean tax inversions have less benefits towards earnings stripping and make accessing foreign profits more difficult.5 New regulations are expected to lower corporate profits for international conglomerates, negatively effecting GDP.

The capital markets started the year off with substantial volatility. Significant positive correlation with oil prices in combination with the poor economic strategizing announcement from the Federal Reserve are likely reasons for this. Near the end of Q1, the markets have gained momentum and oil stagnation has smoothed. We anticipate at least one rate increase this year, rising to .75% and a supporting short term GDP growth of 2.2% in 2016. In the longer horizon, we expect the U.S. to increase GDP growth to an annualized rate of 2.6%, contingent on the implied independence between capital markets and oil prices.

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Consumer Confidence & Sentiment Index

Consumer confidence is a survey put out by the Conference Board that measures the attitudes consumers have towards the economy. Surveyors answer questions about their current and potential future income, employment, and business conditions as a whole. Consumer sentiment is a survey conducted by The University of Michigan. This survey is very similar to the confidence survey, where both numbers are generally very similar to the other. This survey has questions geared toward the attitudes of the individuals towards the economy, and the strength of consumer spending. For Q1 in 2016, U of Michigan’s Consumer Sentiment stayed between the 91 – 95 range, slowly declining. April CSI came in at 89.7, which is lower than the expected 91, but is still a healthy number considering the recent political and macroeconomic growth conditions. 6 We want to keep a close watch on consumer confidence numbers to know what we can expect in revenues from Google Network Members. As confidence remains higher, inclinations to spend more money leads to higher online traffic, and a greater likeliness businesses will continue utilizing their web services. Minor fluctuations in Consumer Confidence will have little to no effect on traffic due to the immense amount of data Google has access to that isn’t related to financial spending habits.

Reports of a slowing in wage gains, inflationary adjusted income weakening, and political uncertainty as it pertains to the economy are contributing to the lower CSI readings. Previous consumer survey data remained extremely high despite more uncertain economic conditions, making this sub-90 rating partially admissible. Non- recessionary years average at a rating of 87.6, while the five recession periods averaged to 69.3; This signaling that we still have far to fall before adjusting.7

We believe that Consumer Confidence will decrease and hang slightly around 94 in the short term while Consumer Sentiment will hit 87.5. These numbers centered around the slight increases in employee compensations, the deteriorating income expectations and the assumption that oil will rebalance and rise in the capital markets. In the long term we anticipate the CCI to increase and stay around 97 and CSI to move back to 93.

Employment

Employment in the U.S. has continued to rise, showing the demand for a larger labor force while further ascertaining the strength of the job market as a whole. This hiring of employees can signal an expansive economy, as companies can afford to hire more workers. Hourly earnings have risen 2.3 percent through 2015, and non-farm payrolls have increased 215,000 – which was 5,000 higher than the consensus.8

Alphabet is known for being one of the most desirable companies to work for in the eyes of millennials and other top programming talent. That being said, they pay large premiums for the upper echelon of talent. Wage growth increasing at a steady rate could induce wage inflation in Alphabet’s corporate setting. Having an already high salary percentage with the expectations of growth may not bode well. In 2015 employment rose from the previous year as a whole, leaving less people without a job. This shows that companies are feeling confident in their operations and futures, as they are making the investment to hire new employees. We feel this is one signal of a strong economy.

The employment cost index (ECI) rose in the fourth quarter of 2015 by .6%. The ECI is a measure of employee wage growth in the United States. This measure is important to monitor because it is useful to

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interpret cost pressures that can have an impact on the inflation rate in the United States.9 The unemployment rate has held steady for year-end 2015, through March 2016 at 5%.10

The graph below shows that unemployment has continued to fall quarter after quarter for the last 2 years rather steadily. This could be because individuals are now more optimistic about finding a job, which can lead to a better performing economy, or because companies are looking to expand their operations and need new talent.

Bureau of Labor Statistics U.S. Department of Labor10

We feel that the economy is continuing to expand, which leads to an increase in employment. In the short-term (6 month outlook), we see the unemployment rate staying at 5%. In the long-term (2-3 year outlook), we see the unemployment rate dropping below 5%, to around 4.7%.

Our belief in this comes from the consumer confidence, which is at a high level right now, showing consumers are feeling positive about their financial future. For the technology sector, we can expect to see an increase in the amount of skilled labor workers getting jobs. The tech field is one of ever changing needs and increased innovation, which will be spurred on by the hiring of new employees.

The technology field is comprised of many successful companies, which leads to cut-throat competition between them, like Apple and Google. One of the best ways for companies to stay innovative is to hire new people who will in turn bring with them new ideas.

Exchange Rates

The exchange rate is the price of a nation's currency in terms of another currency.11 For simplicity, we will be analyzing current exchange rates using the US dollar, as a base currency. Analyzing current exchange rates plays an important role in the technology sector mainly due to the large amount of sales from foreign markets. There has been a notable correlation between the strength of the US dollar and US technology performance. The graph below shows that when the US is dollar is weak, technology performance tends to excel due to foreign buyers having more confidence in the US market.12

Fisher Investments on Technology pg. 56-57

Conversely, there are also benefits for US industries when the US dollar is strong. Products imported from foreign markets will be cheaper to US corporations resulting in lower costs. Companies who have more imports than exports in times of a strong US dollar will benefit more than those who don't.13

Source: Federal Reserve14

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Source: FactSet

Due to recent decline of production recorded by the Purchasing Managers Index (PMI) manufacturing report, we estimate the Trade Weighted US dollar Index to increase to 130 in the next 6 months. However, we predict the Trade Weighted US dollar Index to fall between 100-105 in the next 2-3 years. We believe the main reason for this long-term Trade Weighted US Dollar Index decline is the US export estimates to increase over the next two years.21

We expect Google will benefit from a slight decline in the value of the US dollar due to the importance of foreign revenue for Technology based companies.

Capital Markets Outlook

The technology industry as a whole has performed very well over 2015 (3.39% return from S&P 500 Information Technology Sector), and we see this continuing on into the future. With the increase in online traffic, companies that provide online services are benefitting from more advertising to a broader range of consumers, enhanced developments in the specific technology hardware, and the increases in online sales.22

We feel this is a good time to invest in the internet software and services sector of the tech industry. Alphabet just announced a phenomenal beat on revenue expectations (increase of 18%) as well as beating the expected EPS of 8.09 (actual of 8.67).23 Alphabet is an anchor for the industry, weighted at 54.36% of internet Software and services and 20.65% of the Technology industry as a whole.24

A company similar to Alphabet that has been thriving as of late is Facebook. Over 2015, Facebook's P/E ratio came in at 45.9, well over the S&P 500 average of 16.74. Facebook, due to its operations, makes majority of its revenues off of selling targeted advertisements on their website. Advertising revenue streams for Facebook in 2015 were reported as $17,079 million ($17,928 total revenue), showing how strong they rely on advertising to drive profits.25

With increasing numbers of people using the internet every day, Facebook can expect this number to continue to increase. Due to this, we feel the firm will benefit greatly from the continued success of the technology sector.26

World Index Tech Sector Alphabet Facebook

Industry Description

Internet Software & Services Industry

Alphabet Google falls under the Internet Software & Services sub-industry. The sector has increased in market capitalization by 17%, 16% and 14% respectively over the past three years. 15 Business lines most responsible for their success mainly fall under the internet advertising category. The primary segments offered by Alphabet include Web, Mobile, Business, Media, Geo, Specialized Search, Home & Office, Social, & Innovation. Product offerings from Alphabet consist more of intangibles such as their web service offerings, YouTube, & a wide array of advertising programs. In terms of physical products, Google offers their Chrome Cast media-streaming device and Nest smart-home devices.

World Index Returns Compared to Tech Sector, GOOGL, and FB

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Google Website Revenue Sources

AdWords, Google Chrome, Google toolbars, YouTube, Gmail, Google Finance, Google Maps, Google Play

Google Network Members’ Website Sources

AdSense, AdExchange, AdMob, DoubleClick

Google Other Revenues

Apps and Media content sales in Google Play, Chromecast, Cloud Service Fees, Nest branded hardware, Internet & TV services

Recent Developments & Industry Trends

Google Website Status Update

As the largest portion of Alphabet, Google websites contributed 67.4%, 68.6 % and 70.2% of their GAAP adjusted earnings for the previous three fiscal years.16 We feel the omni-presence of Google will continue to trend upward and preserve its ubiquitous level of awareness. One massive shift currently effecting this line of business is the movement towards more mobile advertising expenditures. Already slightly penetrating the mobile market with their Android operating system, they likely have a capable workforce and solid foundation to swiftly adjust to this new advertising focus.

Another trend in this particular industry sub-section is the growing number of those steering away from TV subscriptions, better known as ‘cord cutters’. Companies have started to prepare for the widespread cancellation of television services as the popularity of streaming media has become increasingly popular. Alphabet holds a good position in this culture change, as they would benefit greatly from an increase in internet based advertising demand. A good benchmarking measurement is the music streaming industry and the impact YouTube creates on it. Record

companies have been attempting to negotiate better terms with YouTube but have found they have minimal leverage. 17 Mentioned later in this report, Alphabet is in the process of launching a subscription based service, YouTube Red, which has the power to attract more traffic, and wider margins for recording deals.

Revenues deriving from programs and email databases are likely to account for the same percentage of profit. In a crowded market, Alphabet is positioned to remain a big player, but unlikely to capture more market share.

Google Network Members’ Websites

Recognized income from Google’s other websites has made up 24.6%, 22.1%, and 20.2% the past three years. 18 The decrease in growth can be explained by the inability to keep up with the growth experienced from Google websites. Revenues did manage a $500 million increase, but this numbers’ reliance on the overall growth of the global economy must be recognized. Slowing development in this category reflects on the deceleration experienced in the global economy for the most recent fiscal year. Income from the rest of the world (which excludes the United States & United Kingdom) make up 44% of all Googles consolidated revenues. 19 Coming off of a 23% increase in this category, they weakened to a 10% growth in 2015. Lackluster growth combined with the strong dollar caused this category to have a less than impressive year.

Google Other Revenues

Alphabet has much room to grow in this category and the restructuring of ‘Google’ into ‘Alphabet’ was a step in the right direction. Currently, there is not a wide variety of contributors to this revenue stream. However, the industry which this Alphabet’s other revenues falls under is not clear cut; the plan being to invest in new businesses, products, infrastructure improvements and acquisitions. 20 Nest products make up most of these figures, but we feel these products are before their adoption time and are not accurately represented well by their sales numbers. Forward looking, this division of Alphabet should not be categorized unambiguously. Our DCF model’s assumptions anticipate these figures to grow exponentially as they start to create new innovative and lucrative products. Beginning with the driverless car, Alphabet is arguably the front runner for this soon-to-

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Source: FactSet

market technological innovation which could deliver a large shock to the transportation industry. This market exalts a feast-or-famine product acceptance style which is perfectly in line with Alphabet’s ability to fund new projects.

Ticker Market Cap (b) 

P/S Cash (b) 

Cash as % of Rev 

GOOGL  $ 535  7.33  $ 16.55  22.5% 

MSFT  $ 446.6  3.92  $ 5.60  6.03% 

YHOO  $ 34.5  6.28  $ 2.66  53.46% 

AAPL  $ 595.9  2.76  $ 21.12  9.13% 

FB  $ 314.4  16.66  $ 4.9  27.33% 

TWTR  $ 1.2  6.91  $ .91  31.38% 

BIDUexp  $ 6.6  6.27  $ 1.38  13.17% 

Markets & Competition

While Alphabet is characterized in the internet software and services industry, they operate under many different subsectors. Majority of revenues coming from advertising operations gives reason to classify Alphabet under the advertising industry, but their heavily technological weighted products give reason to organize them elsewhere. Competitors work under very similar principals, making it less clear who their largest contenders are.

Emergence into this market is not an easy task, yet those who have succeeded in earning relevance are capable of capturing more market share. That is one of the benefits of operating in such a large industry, Alphabet can better adjust due to necessary capital investment and time commitment. We feel our largest overall threat in this industry is Facebook (FB). Our reasoning for this is their versatility in the eye of the consumer. Originally considered merely a social networking platform, is now creating advanced algorithms and being used for measurable analytics in the presidential race. Facebook is another company that does not shy away from entering a market which it has no experience in- acquisition Oculus, a virtual reality headset creator. We believe Apple (AAPL) is a close second because of their product line offering in comparison to Alphabet. They sell more tangible items that don’t exactly align with Alphabet, thus capturing less market share from their most profitable operations.

Microsoft (MSFT) while it is a large company, they have focus more on polishing their current products, focusing on better operating margins. Twitter (TWTR) could have been considered a larger threat if it weren’t for its recent downgrade in the eyes of investors and their lack of confidence. Baidu (BIDU) is a popular search engine in Asia. They operate the closest to Google, however their size and niche target segment minimizes their threat level. Lastly, Yahoo (YHOO) is fighting a losing battle in the crowded search engine market. Consecutive poor decisions deem them irrelevant in the long term. Loyalty in the search engine industry allows Alphabet to maintain its lead while brushing off attempts of those that can’t keep up with innovation.

Catalysts for Growth/Change

Companies in the Internet Software & Services Industry are already some of the largest companies in the world when compared by market cap, however they all keep trying to grow through innovation and new ideas. We believe new projects and product lines will be catalysts for growth in these companies. Due to their massive amounts of cash, these companies can afford to invest in futuristic ideas with massive overhead costs and little revenues, but massive potential for another source of company revenue. 28

Aforementioned in this report, we foresee Alphabet leading the charge into the driverless car age. Visualizing future earnings potential for Alphabet, Facebook, and Apple requires out of the box thinking because they are in the business of innovation. For the internet services industry as whole, the issue of server bandwidth and physical computer space for said servers is a significant factor. All companies capable of heavy internet traffic need to be properly equipped to handle the flow, if upgrades these system efficiencies were captured, COGs could drastically decrease. Cost of revenues for Facebook increased 33% or $714 million to keep up with data infrastructure in 2015, accounting for 17% of overall revenues.29

Subsequently, traffic acquisition costs (TAC) for Google make up 37.6% of their revenues.30 Google Fiber is a project Alphabet has been pursuing which provides fiber optic internet service in large cities. This could be a precursor for reaching lower operating costs.

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Transitioning to new ways of accessing technology has a large impact on the industry. Moving towards more mobile devices is one direction of adjustment which came to strictly because of the way consumers chose to digest their information. Consumer behavior will have the largest effect on the internet industry due to its ever-changing structure. Using their extremely popular and free analytics and data analysis software, Alphabet has the tools to stay ahead of this curve and prevent missing out on opportunities. Google previously attempted to get into the wearable market with their ‘Google Glass’ design- their take on smart glasses. However, this product was unsuccessful and they have since completely stopped supporting it. Wearable technology has become more accepted and present an opportunity for future advertising methods and taking advantage of the internet of things.

Key Investment Positive & Negatives

Positives Electronic Device Demand

The largest distributor of internet enabled devices (phone, computer, tablet), Apple, continues to see increases in sales numbers year by year. Apple sold 28% more internet enabled devices in 2015 than in 2014. 31 This is an important metric for companies that deal in the internet software and services industry, showing the increasing number of users they can reach and monetize. Google, Twitter, and Facebook will all benefit by there being more internet traffic, theoretically allowing them to charge more for their advertising. This industry depends on users owning devices that enable them to connect to the internet, and with increasing sales in these devices brings more traffic to their websites.

Comfortably Levered in Industry

Alphabet operates at very comfortable debt-to-equity in accordance with such a cut throat, research and development intensive industry. If a recession were occur, Google would remain a sound investment without carrying too much market risk. Having this in combination with creating efficient operating margins makes this stock an attractive value opportunity.

Relentless Innovation

Innovation in the internet software and services industry is key for a company to be successful. Without

this quality, other companies can easily come up with a product or service that is more user friendly or better made than the previous, rendering a product obsolete with little warning. This competition between the three main companies here is a positive for the investor because it shows the growth in the industry as a whole. There are big players in this field, such as Alphabet and Facebook, but new companies continue to try rise up in this industry, which forces other companies to push the envelope. A quality benchmark measurement of a firm’s innovation can be seen through R&D. In 2014, Facebook purchased WhatsApp for $17.2 billion. This move was done to try and expand services into different parts of the world, as the app had users from many different countries, including third world nations. This move enables them to reach different markets and users from all around the world, and gave them an advantage over other platforms. 32

Negatives All Eyes on Alphabet

This is more of a caveat to the positive investment keys of large competition and constant innovation. Both of those factors, while positive, lead to a large threat of substitution. Google has recently been getting themselves in hot water due to the neglect to abide by foreign laws. The EU in particular, has filed multiple law suits toward them for disregarding their ‘failure to be forgotten law’. 33 This is cause for some concern due to their track record- they have already been banned from China for similar reasons. In a more recent case with Google, they have been scrutinized and subpoenaed for scanning in over 20 million books into their own database for searching purposes.34 In this

Source: Alphabet 10-K, Yahoo 10-K, Facebook 10-K

2015

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Google Other 

Revenues, $7,151 

Other Bets, $448 

Google Websites, $52,357 

Network Members' Websites,  $15,033 

Advertising Revenues, $67,390 

REVENUE STREAMSindustry where bold decisions make or break companies, being the first to revolutionize will come with difficulties which can include unexpected financial hemorrhaging.

Cyber Threats

Cyber security is a severe issue that can arise in the internet software and services industry. The increasing amount of users online, makes much information susceptible, putting it at risk for being stolen or used illegally- discrediting the company’s reputation. To Alphabet’s benefit, Facebook is also at risk getting into trouble with cyber security. Unlike alphabet, Facebook takes users information into account when supplying adds to users. Advertisements on their website drive 92% of their revenues, a massive portion of the firms overall revenues. If this information that they have stored on their users gets out, users could feel unsafe with having their information on there, and leave Facebook, which would then subsequently lower the going rate for advertisement deals.35

Company Specific Analysis

Company Overview

Alphabet Inc. (GOOGL) is the contemporary goliath of innovation and advertising powerhouse of the Internet Software & Services industry. It was founded in 1998, headquartered in Mountain View, California. Originally providing just a search engine, Alphabet now holds 8 distinct subsidiaries specializing from anti-aging research labs to self-driving cars. As a company, they focus mainly on cultivating creativity and solving large problems. Implementing a “what if” attitude has allowed Alphabet to become the second largest publicly traded company in the world with an attractive future.

Products & Revenue Generation

Previously Google, the company announced in August 2015 the creation of their new holding company, Alphabet – with the intention to broaden its product/service offerings. Posting an 89.8% revenue from advertising shows the company operates with great margins and minimal inventory requirements.

Google Websites – An account on the financials which includes AdWords on their personal website. Also includes other first tier products such as YouTube, Gmail, Maps and Finance. Paid per clicks advertisements in 2015 increased 4% to reach 33%, mainly attributed to the increase in engagement ads. Adoption of this new style ad may increase the popularity and effectiveness of these tools.36 We anticipate 22% growth for this division for the next 2 years from success capture of mobile market share and Yahoo’s losses. After we expect it to slow by 4% each year until reaching economic growth.

Google Network Members’ Websites – Revenues that derive from AdSense, AdExchange and other websites that use Googles advertising services. These streams rely on the health and growth of other businesses. We can expect these revenues to be positively correlated with the growth of the online shopping, and consumer confidence. This division is also very reflective on the economic growth. However, due to the cord cutting phenomena we feel 2016 will deliver an 8% grow rate relative to previous year performance, then decelerate to 6 - 7 % before reaching economic growth.

Google Other Revenues– Inflows from operations other than advertising include the sale of content via the Google Play store, licensing, and the sale of hardware – Chromecast and Nest. We believe Chromecast is nearing market saturation. As year-over-year sales halved in 2015, lowering to 18.2% from previously reaching 36.4%. Revenues from Nest products have increased 121 million from 327 to 448 in 2015. The division being acquired in early 2014, these numbers don’t give much insight for future expectations.37 We expect rapid growth in this division

Source: Google 10-K 2015

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Source: Yahoo Finance, ThomsonONE

Source: FactSet

at 35% due to the perceived success of new ventures near completion.

Analysis of Recent Filings (Earnings & Guidance)

Alphabet has beaten their expected EPS as well as revenues for 3 of the 4 quarters in 2015. The Google segment of Alphabet doesn’t commonly release guidance around earnings time, however they have continued to grow exponentially alongside lackluster analyst speculations. Upon receiving the successful Q4 2015 earnings report, few important key metrics stand out. Google’s operating margins have consistently reached high levels above 25% - currently at 26.2%.38 In comparison to other competition in the Internet Search industry, Alphabet’s numbers have shown great profitability from operations while expecting long term increases. Posting these types of operating margins whilst simultaneously working towards monetizing new ventures reflects their conscientiousness to expand at a healthy rate.

Ticker OP 

Margin OPM YoY Change 

D/E 

GOOGL  26.20%  3.16%  4.34% 

MSFT  29.65%  ‐7.43%  44.07% 

YHOO  ‐2.72%  ‐157.26%  4.25% 

AAPL  33.68%  .61%  54.01% 

FB  45.57%  ‐4.19  ‐40.98% 

BIDUexp  15.77%  ‐24.94%  48.44% 

Comparison between Alphabet’s profitable competitors in FY2015 allows investors to find solace when trying to justify the company long term plans. Relying heavily on R&D, Alphabet will need to

continually find sources of funding. Maintaining an extremely low debt responsibility they should have little obstacles funding future endeavors, regardless of the economies’ status.

Competition & Differentiation

The Google segment faces the most search engine opposition, however they currently pose little threat. Globally – as of January 2016, Google holds 65.44% of the market share. Remaining usage falls primarily into the hands of Bing (15.82%), Baidu (8.3%), and Yahoo (8.28%). Moving ahead, we anticipate multiple opportunities for other companies to cannibalize market share.

Bing – Microsoft’s Bing poses the biggest potential threat to Google in the search engine industry. In 2012, they launched the campaign “Bing it on” as an attempt to demonstrate they were the better search engine via blind comparison. Advertising for search engine use was uncommon up to this point; the campaign increased visibility. Browser use is a significant contributor when determining search engine use. People using Windows Operating Systems are more likely to use Bing, as it automatically is chosen as the browser. 39

Facebook – Previously mentioned in this report, we feel Facebook is the largest overall competitor which is most capable of capturing pertinent marketshare. We believe Alphabet is an unorthodox company, leaving its biggest threat to be those that are more unconventional. In a study of 5,000, 60% of Millennials said that keeping up with news is a daily online activity. Directly lagging behind at 59%, is keeping up with what friends are doing.40 Facebook updates their product weekly, moving closer to

6.936.74

7.21

8.10

6.88 6.99

7.35

8.67

6

6.5

7

7.5

8

8.5

9

Q1 Q2 Q3 Q4

EPS Actual vs Estimates (FY 2015)

EPS Estimates EPS Actual

65.44%15.82%

8.30%

8.28%

0.24%

0.15%Total Global Market Share(US searches per yr) 

GoogleBingBaiduYahooAskAOL

Source: NetMarketShare

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capturing more of the search engine market. Millennials are the largest populated age cohort, a shift towards Facebook’s search engine could be detrimental to Alphabet’s revenues. Baidu – After more Google products were banned in China in late 2014, it proposed a great entry point for another company to step in. With the search engine already prohibited in 2009, Baidu was still unable to capitalize and create significant growth in revenue for the subsequent quarter. CEO Robin Li believes Google wouldn’t pose a major threat, and claims mobile will eventually render their core business obsolete.41

Inability to adapt to the obvious market demands signals contempt in their current state. Before being banned, Google held around 33% of the market while Baidu held a little over 60% Google has been fighting to reestablish itself in China, if successful, they have a much higher chance of capturing the mobile market. Apple – While not considering Apple as our most viable competition, they still have the potential to leave a big impact. As the clear front runner for phone sales, they have a large following which has a strong influence on Alphabet’s Android sales. iPhone products have many ‘make or break’ qualities that consumers feel are a nowhere near being replicated by competition. Damaging phone sales is a serious issue, however if they were able to proprietarily hold mobile advertising market share unique to iPhones, Alphabet would suffer massive loss. This may not be an issue at hand but with Apple cutting iPhone output by 10%, they may aggressively search for new sources of revenues such as this. 42 Yahoo – Out of Google’s largest competitors, Yahoo is the least likely candidate to capture any more market share. Losing touch with their demographic and failing to improve has led them to their current position of non-profitability. CEO Marissa Mayer has announced a restructuring strategy that appears more as a last stand to turn the company around. Trading at a considerable acquisition price, we believe they are preparing to change hands and should continue to lose market share.

Catalysts for Growth/Change

Advertising revenue is the clear victor when determining branches of profitability within Alphabet. Carrying expectations for future growth in Network Members Websites will also bring an increase in Traffic Acquisition Costs (TAC). Revenues increased $494 million in 2015 to reach $15,033 million. TAC costs to Google Network Members increased $378 million to reach $10,242. Cost of revenues as related to network members increased from 67.85% to 68.13% in 2015. 43 In order for Alphabet to make efficient use of their future growth in this category, they will need to focus more on ways to reduce operating costs. If a method of higher profit retention is discovered, it will present a considerable opportunity for future performance.

Key Investment Positives & Negatives Positives Diversified Entity Structure Alphabet has deeply rooted itself into the advertising market but has also branched itself into a widely diversified product variety- bestowing a stop-loss benefit for revenue forfeiture. Pushing new revolutionary products first, they have much more flexibility with margin spreads, avoiding status quo pricing models. Alphabet exercised great timing by restructuring their company at the time they did. Having high cash profits gives them lots of free reign to finance new ventures, making them less risky for investment.

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Attracting Talent

Google’s work environment is considered utopic in the eyes of millennial workers entering the work force. Exposure as a company who takes pride in their employees as well as compensating them extraordinarily well with benefits goes a long way with younger talent. These Google specific benefits allow them to recruit top talent without having spent too much time recruiting. Yearly events at the HackMIT hosted by Massachusetts Institute of Technology is an event where Google discovers top computer hacking at a low cost while simultaneously improving their security.44

Negatives Acquisition Turmoil

Taking over companies for the foreseen potential is fair reasoning to acquire a company up to a point. Alphabet has previously obtained companies with great intentions but have found themselves somewhat in over their heads. Boston Dynamics- a robotics company Google took over in 2013- seemed like a radical decision at first. However, the once CEO of that had passed, they lost the ingenuity and hit a brick wall with progress. Boston Dynamics has since been put up for sale from Google- with no potential buyers.45 Another example of this comes from the management brought over from Nest. Productivity had experienced a drastic slowdown as the work force of the subsidiary felt overworked. 46 Since then, Nest has had a shakeup with executive and lower level positions. These are signals that Alphabet needs to qualify their impending acquisitions with more thorough examination.

Valuation Analysis

Key Assumptions

Revenue Decomposition

Alphabet Inc. obtains roughly 90% of its current total revenue from advertising operations. This business segment is vital for Alphabet to focus on. Therefore, we predict advertising revenues to increase at a decreasing rate until final growth year 2020, where it converges at 4.5%.

In 2012 and 2013 Alphabet earned close to $8 billion in revenue from Motorola Mobility. This acquisition showed the ability to diversify revenue sources outside the realm of advertising. The idea of Alphabet expanding into new products is consistent with our belief for their future as a company. We expect Alphabet to be a leader in cutting-edge technology over the next 5 years, and can expect revenue sources labeled “other” to be broken down into specific categories. Our forecasted growth rates for other revenues increases by 35% in 2016 and converges down to 4.5% in 2020.

Cost of Goods Sold/R&D

For the past 10 years Alphabet’s COGS and R&D have increased every year. These numbers support our belief that Alphabet is a leader in innovation and product development. In our 5 year forecast we believe Alphabet will continue to expand into new products which will cause COGS to increase by more than 30% and R&D to rise by approximately 18%. Alphabets historical R&D numbers and company vision align with our future predictions.

Weighted Average Cost of Capital

Alphabet’s Weighted Average cost of Capital (WACC) was calculated at 6.92%. To obtain this number we first calculated the Cost of Equity using the Capital Asset Pricing Model approach. To complete this model we used Bloomberg to find the raw Beta of Alphabet and the risk free rate. We then calculated the Market Risk Premium to get a final cost of equity value of 7.02%.

We then continued on to compute the Cost of Debt by multiplying the Pre-Tax Cost of debt by the Marginal Tax Rate to yield an after-tax cost of debt at 2.32%. Capital Structure Weights were than applied to calculate the market value of equity by multiplying current shares outstanding by the current market price to equal $521,967. The book value of debt was then calculated by adding long-term debt, short-term debt, and present value of operating leases equaling $10,699. The WACC of 6.92% was then applied to the DCF and EP approach, presented next.

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Discounted Cash Flow and Economic Profit

Our DCF and EP model both yielded an intrinsic value of $843.94 which was then adjusted to $861.32 for the elapsed fraction of the year. This model predicts a 14.5% increase from the current value of $751.72. The market is possibly underestimating Alphabet’s future potential to generate revenue from other sources. So, based on this approach we believe that the stock is currently undervalued.

Dividend Discount Model

Before performing any valuation models we estimated Alphabet’s stock price to increase by 15%-20% over the upcoming year. The Dividend Discount model yielded an intrinsic stock price far below the current trading value at $495. Alphabet does not currently pay a dividend so we used industry averages to complete this model. Since Alphabet is a high-growth company and is not similar to many companies in their industry, we believe that this model should be discredited due to its lack of accuracy.

Relative Valuation

Comparing Alphabet to other similar companies is a tough task. Alphabet is in a stage of high-growth with an incomprehensible level of future potential. However, we were able to find 4 companies that had similarities suitable for this model. After removing several company outliers we chose Apple, Twitter, Baidu, and Facebook. We calculated each companies’ EPS and P/E ratio for 2016 and 2017 to finally obtain the PEG ratio in each of those years. We then compared the previous companies to Alphabets similar ratios, obtaining the Relative P/E for 2016 at $591.81 and the PEG ratio for 2016 at $219.60. These values are considerably low and should not be acknowledged when issuing a rating. As stated earlier, Alphabet is a very unique company and relying on valuations that only compare ratios to other companies is not adequate.

Sensitivity Analyses PP&E Growth Rate to Other SG&A Expense: These two variables were chosen to reflect potential growth in Google’s long-term assets and other expenses not related to production of goods. SG&A expense is one of the biggest operating expenses Alphabet currently shows on its income statement. PP&E has a very large impact on Total assets and testing these two important metrics yielded us a intrinsic value range between $1,047 and $639. COGS Growth Rate to Marginal Tax Rate: Cost of Goods Sold (COGS) is another important operating expense that must be monitored. An increase in COGS can represent better company performance or a need to look at pricing of production. Marginal Tax Rate is a simple yet important company specific factor but it is also affected by government policies. These comparisons yielded us a stock price between $1,069 and $619. Economic Growth Rate to Network Member Ad Growth Rate: Advertising revenue is currently a majority of total revenue for Alphabet. Tracking a specific sector of that revenue is important to watch how Alphabet maintains its dominance. The economic growth rate is a great metric to track how Alphabet advertising revenue correlates to the overall economy. These two variables were positively correlated and this sensitivity analysis yielded a range between $934 and $751. R&D Growth Rate to WACC: Research and Development growth rate is a significant variable surrounding Alphabet. We predict that this number will increase over the next 3-4 years and it is an interesting comparison to the weighted average cost of capital. As predicted a higher share price is created when R&D growth rate increases and the WACC decreases. The range for this analysis is $1,010 to $740.

Important Disclaimer

This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report

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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. 1 Bureau of Labor Statistics 2 Bureau of Labor Statistics

3 Bureau of Economic Analysis 4 Federal Reserve ( Chart & Data used for predictions) 5 Wall Street Journal <http://www.nasdaq.com/article/us-sets-tougher-rules-on-tax-deals-20160405-00054 >

6 The Conference Board, Consumer Research Center 7 Surveys of Consumers University of Michigan < http://www.sca.isr.umich.edu/ >

8 Bureau of Labor Statistics < http://www.bls.gov/web/empsit/ceshighlights.pdf > 9BloombergNews http://www.bloomberg.com/news/articles/2016-01-29/fourth-quarter-growth-sentiment-cool-u-s-economic-takeaways

10 Bureau of Labor Statistics U.S. Department of Labor http://www.bls.gov/news.release/pdf/empsit.pdf 11Investopedia http://www.investopedia.com/terms/e/exchangerate.asp 12 Fisher Investments on Technology (pg. 56-67)

13 Investopedia http://www.investopedia.com/articles/forex/051415/pros-cons-strong-dollar.asp 14 Investopedia

http://www.investopedia.com/terms/t/trade-weighteddollar.asp 15 NetAdvantage Standards & Poors: < Sub Industry review IT Software & Services > 16 Alphabet 10-K, 2015 17 Wall Street Journal < Streaming Gives Music Industry a Lift—Global Revenue from recorded music grew 3.2% >

18 Alphabet 10-K, 2015 19 Alphabet 10-K, 2015 20 Q4 Earnings Report Minutes 21Factset

22S&P500InformationTechnology <http://us.spindices.com/indices/equity/sp-500-information-technology-sector/> 23 Alphabet 10-Q, Q4 24 Factset 25 Facebook 10-K, 2015 26 FactSet S&P 500 index

27 FactSet Data 28 The Guardian <https://www.theguardian.com/technology/2016/feb/05/x-projects-alphabet-moonshot-ventures-change-world-robots> 29 Facebook 10-K, 2015 30 Alphabet 10-K, 2015 31 Apple 10-K, 2015 32 Tech Radar < Facebook Buying Whatsapp- it’s about the Developing World> 33 Bloomberg: Technology <Google and EU Wrangle Over ‘Right To Be Forgotten’> 34 Wall Street Journal <Supreme Court Rejects Challenge to Google book-scanning Project> 35 Facebook 10-K, 2015 36 Alphabet 10-K, 2015 37 Alphabet 10-K, 2015 38 FactSet 39 Forbes <http://www.forbes.com/sites/jaysondemers/2015/02/04/is-bing-finally-catching-up-to-google/3/#5ed26ec86e72> 40 AmericanPress Institute: Media Insight Project 41 Wall Street Journal <http://blogs.wsj.com/chinarealtime/2016/02/15/baidus-robin-li-on-search-giants-success-it-isnt-because-google-left-china/> 42 Credit Suisse Analyst Report 43 Alphabet 10-K, 2015 44 Massachusetts Institute of Technology: HackMIT 45 Bloomberg: Technology < Google Seeks Buyer for BD > 46 Business Insider < What is going on at Nest>

Other SG&A Expense843.94$ 17.00% 18.00% 19.00% 20.00% 21.00% 22.00% 23.00%

0.31 1047.55 974.08 900.62 827.15 753.68 680.22 606.750.29 1053.24 979.77 906.30 832.83 759.37 685.90 612.430.27 1058.83 985.37 911.90 838.43 764.96 691.50 618.03

PP&E Growth Rate 2016-2017 0.25 1064.34 990.88 917.41 843.94 770.47 697.01 623.540.23 1069.77 996.30 922.83 849.36 775.90 702.43 628.960.21 1075.10 1001.64 928.17 854.70 781.23 707.77 634.300.19 1080.35 1006.88 933.42 859.95 786.48 713.02 639.55

Marginal Tax Rate843.94$ 22% 23% 24% 25% 26% 27% 28%35.70% 618.56 620.22 621.88 623.54 625.20 626.86 628.5234.70% 692.03 693.69 695.35 697.01 698.67 700.33 701.9933.70% 765.49 767.15 768.81 770.47 772.13 773.79 775.45

COGS Growth Rate 32.70% 838.96 840.62 842.28 843.94 845.60 847.26 848.9231.70% 912.43 914.09 915.75 917.41 919.07 920.73 922.3930.70% 985.89 987.55 989.21 990.88 992.54 994.20 995.8629.70% 1059.36 1061.02 1062.68 1064.34 1066.00 1067.66 1069.32

Network Member Ad Growth Rate843.94$ 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 11.00%

4.80% 934.88 937.47 940.08 942.73 945.39 948.08 950.794.70% 899.33 901.81 904.31 906.83 909.38 911.95 914.554.60% 866.84 869.21 871.61 874.03 876.47 878.94 881.43

Economic Growth Rate 4.50% 837.03 839.32 841.62 843.94 846.29 848.65 851.044.40% 809.59 811.79 814.00 816.24 818.49 820.77 823.064.30% 784.25 786.36 788.49 790.64 792.82 795.01 797.224.20% 760.76 762.80 764.86 766.93 769.03 771.14 773.284.10% 738.94 740.91 742.90 744.90 746.93 748.97 751.03

WACC843.94$ 6.32% 6.52% 6.72% 6.92% 7.12% 7.32% 7.52%

19% 1010.05 913.08 833.59 766.71 711.04 662.82 620.9918% 1045.30 944.62 862.10 792.67 734.88 684.82 641.4017% 1080.25 975.90 890.37 818.41 758.52 706.64 661.64

R&D Growth Rate 16% 1114.90 1006.92 918.41 843.94 781.96 728.28 681.7115% 1149.26 1037.67 946.20 869.25 805.21 749.73 701.6114% 1183.32 1068.16 973.76 894.34 828.25 771.00 721.3413% 1217.09 1098.38 1001.08 919.22 851.09 792.08 740.90

Alphabet, Inc.Revenue Decomposition

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

Google Websites 37,422 45,085 52,357 63,912 78,017 92,114 103,231 107,877

Growth YoY 19.86% 20.48% 16.13% 22.07% 22.07% 18.07% 12.07% 4.50%

Google Network Members 13,650 14,539 15,033 16,236 17,534 18,762 19,888 20,783

Growth YoY 9.51% 6.51% 3.40% 8.00% 8.00% 7.00% 6.00% 4.50%

Total advertising revenues 51,072 59,624 67,390 80,147 95,551 110,876 123,119 128,659

Growth YoY 16.91% 16.74% 13.02% 18.93% 19.22% 16.04% 11.04% 4.50%

Google other revenues 4,435 6,050 7,151 9,654 12,067 15,084 17,347 18,127

Growth YoY 88.48% 36.41% 18.20% 35.00% 25.00% 25.00% 15.00% 4.50%

Google segment revenue 55,507 65,674 74,541 89,801 107,618 125,960 140,466 146,786

Growth YoY 20.57% 18.32% 13.50% 20.47% 19.84% 17.04% 11.52% 4.50%

Motorola Mobility revenue 4,443 - - - - - - -

Nest & Hardware revenue 12 327 448 493 542 596 656 685

Growth YoY 0% 2625% 37% 10% 10% 10% 10% 4.50%

Total Revenue 59,962 66,001 74,989 90,294 108,161 126,556 141,121 147,472

Growth YoY 19.51% 10.07% 13.62% 20.41% 19.79% 17.01% 11.51% 4.50%

Alphabet, Inc.Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV 2020ERevenues 59,825 66,001 74,989 90,294 108,161 126,556 141,121 147,472 COGS Excluding D&A 21,919 20,712 23,101 29,526 35,368 41,384 46,147 48,223

Depreciation 2,781 3,523 4,132 4,253 5,094 5,961 6,647 6,946 Amortization of Intangibles 1,158 1,456 931 1,255 1,503 1,759 1,962 2,050

Gross Income 33,967 40,310 46,825 55,260 66,194 77,452 86,366 90,253 SG&A Expense

Research & Development 7,137 9,832 12,282 16,831 20,161 23,590 27,364 31,743 Other SG&A Expense 10,986 13,982 15,183 18,059 21,632 25,311 28,224 29,494

Total operating expenses 18,123 23,814 27,465 34,890 41,793 48,901 55,589 61,237 EBIT (Operating Income) 15,844 16,496 19,360 20,370 24,401 28,551 30,778 29,016

Interest Income 785 746 999 1,743 2,087 2,443 2,724 2,846 Interest Expense (83) (101) (104) (107) (109) (112) (115) (118)

Gains (losses) on investments and securities 201 312 (334) 451 541 633 706 737 Impairment of equity investments - - - - - - - -

Foreign exchange gains (losses) (379) (402) (422) (632) (757) (886) (988) (1,032) Gain (loss) on divestiture of business (57) - - - - - - -

Other income (expense) 63 82 152 722 973 1,266 1,411 1,475 Pretax income 16,374 17,133 19,651 22,548 27,136 31,894 34,515 32,924

Income Taxes 2,798 3,331 3,303 6,041 7,236 8,467 9,441 9,866 Net Income 13,576 13,802 16,348 16,508 19,900 23,427 25,074 23,058

Basic EPS 20.21$ 20.29$ 23.78$ 23.66 28.09 32.58 34.36 31.14 Total Shares Outstanding 671.66 680.17 687.35 697.7 708.4 719.1 729.8 740.5Dividend Per Share 0 0 0 0 0 0 0 0

Alphabet, Inc.Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV 2020EAssetsCash and Cash Equivalents 18,898 18,347 16,549 24,160 40,516 61,924 87,626 113,373 Marketable Securities 39,819 46,048 56,517 57,543 58,588 59,652 60,736 61,839 Accounts Receivable, Net 8,882 9,383 11,556 11,787 12,023 12,263 12,509 12,759 Inventories 426 - - - - - - - Deferred Income Taxes, net 1,526 - - 198 237 277 309 323 Other Current Assets 3,335 4,878 5,492 7,124 8,534 11,251 12,546 13,111 Total Current Assets 72,886 78,656 90,114 100,813 119,898 145,368 173,726 201,404

Prepaid Revenue share, expenses and other assets, non-current 1,976 3,187 3,181 4,063 4,867 5,695 6,350 6,636 Non-marketable equity securities 1,976 3,079 5,183 5,545.81 5,934.02 6,349.40 6,730.36 7,033.23 Property and equipment, net 16,524 23,883 29,016 36,270 45,338 52,138 57,352 59,933 Intangible Assets, net 6,066 4,607 3,847 3,270 2,779 2,363 2,008 1,707 Goodwill 11,492 15,599 15,869 15,869 15,869 15,869 15,869 15,869 Deferred Income Taxes net, non-current - 176 251 422 506 592 660 690 Total Assets 110,920 129,187 147,461 166,253 195,191 228,374 262,696 293,272

LiabilitiesAccounts Payable 2,453 1,715 1,931 1,978 2,369 2,772 3,091 3,230 Short-term debt 3,009 2,009 3,225 2,933 3,514 4,111 4,584 4,791 Accrued compensation & benefits 2,502 3,069 3,539 3,825 4,582 5,361 5,978 6,247 Accrued expenses & other current liabilities 3,755 4,408 4,768 3,849 4,610 5,395 6,015 6,286 Accrued revenue share 1,729 1,952 2,329 2,709 3,245 3,797 4,234 4,424 Securities lending payable 1,374 2,778 2,428 2,386 2,858 3,344 3,729 3,897 Deferred revenue 1,062 752 788 1,156 1,385 1,621 1,807 1,889 Income taxes payable, net 24 96 302 188 226 264 294 308 Total Current Liabilities 15,908 16,779 19,310 19,024 22,788 26,664 29,733 31,071

Long-term debt 2,236 3,228 1,995 1,596 1,277 1,021 817 654 Deferred revenue, non-current 139 104 151 154 185 216 241 252 Income taxes payable, net, non-current 2,638 3,340 3,663 4,594 5,503 6,439 7,180 7,503 Deferred income taxes, net, non-current 1,947 758 189 1,353 1,620 1,896 2,114 2,209 Other long-term liabilities 743 1,118 1,822 1,209 1,449 1,695 1,890 1,975 Total Liabilities 23,611 25,327 27,130 27,930 32,822 37,932 41,975 43,664

Class A & B common stock & additional paid-in capital 25,922 28,767 32,982 34,466 38,612 43,258 48,461 54,291 Accumulated other comprehensive income 125 27 (1,874) (1,874) (1,874) (1,874) (1,874) (1,874) Retained Earnings 61,262 75,066 89,223 105,731 125,631 149,058 174,133 197,191 Total Stockholders Equity 87,309 103,860 120,331 138,323 162,369 190,442 220,720 249,608 Total Liabilities and stockholders equity 110,920 129,187 147,461 166,253 195,191 228,374 262,696 293,272

Alphabet, Inc.Cash Flow Statement

Fiscal Years Ending Dec. 31 2013 2014 2015Operating Activities Net Income 12,920 14,444 16,348 Adjustments:

Depreciation & amoritization of property & equipment 2,781 3,523 4,132

Amoritization of intangibles & other assets 1,158 1,456 931

Stock-based compensation 3,343 4,279 5,203

Excess tax benefits from stock-based award activity (481) (648) (548)

Deferred Income taxes (437) (104) (179)

Impairment of equity investments - - -

Other, net (594) (938) 546

Changes in assets and liabilitites:

Accounts Receivable (1,307) (1,641) (2,094)

Income taxes, net 401 283 (179)

Prepaid Revenue share, expenses & other assets (930) 459 (318)

Accounts Payable 605 436 203

Accrued expenses & other liabilities 713 757 1,597

Accrued revenue share 254 245 339

Deferred revenue 233 (175) 43

Net cash flows from operating activities 18,659 22,376 26,024

Investing ActivitiesPurchases of property & equipment (7,358) (10,959) (9,915)

Purchases of marketable securities (45,444) (56,310) (74,368)

Maturities and sales of marketable securities 38,314 51,315 62,905

Investments in non-marketable equity securities (569) (1,227) (2,172)

Cash Collateral received (returned) from securities lending (299) 1,403 (350)

Investments in reverse repurchase agreements 600 (775) 425

Business acquisitions (1,448) (4,888) (236)

Other 2,525 386 -

Net cash flows from investing activities (13,679) (21,055) (23,711)

Financing ActivitiesNet proceeds (payments) from stock-based award activities (781) (2,069) (2,375)

Excess tax benefits from stock-based award activity 481 648 548

Repurchase of common stock in connection with acquisitions - - -

Proceeds from issuance of debt, net 10,768 11,625 13,705

Repayment of Debt (11,325) (11,643) (13,728)

Net proceeds from a public offering - - -

Other (1,827)

Net cash flows from financing activities (857) (1,439) (3,677) Effect of exchange rate changes on cash and cash equivalents (3) (433) (434)

Net increase (decrease) in cash & cash equivalents 4,120 (551) (1,798) Cash & cash equivalents at the beginning of year 14,778 18,898 18,347 Cash & cash equivalents at the end of the year 18,898 18,347 16,549

Alphabet, Inc.Forecasted Cash Flow Statement

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E CV 2020EOperating Activities Net Income 16,508 19,900 23,427 25,074 23,058 Adjustments to reconcile net income to cash from operating activities:

Depreciation and Amoritization 5,508 6,598 7,720 8,608 8,996

Accounts Receivable, net (231) (236) (240) (245) (250)

Inventories - - - - - Deferred Income Taxes, net (198) (39) (40) (32) (14)

Other Current Assets (1,632) (1,410) (2,717) (1,295) (565)

Prepaid Revenue share, expenses and other assets, non-current (882) (804) (828) (655) (286)

Deferred Income Taxes net, non-current (171) (84) (86) (68) (30)

Accounts Payable 47 391 403 319 139

Accrued compensation & benefits 286 757 779 617 269

Accrued expenses & other current liabilities (919) 762 784 621 271

Accrued revenue share 380 536 552 437 191

Deferred revenue 368 229 236 187 81

Income taxes payable, net (114) 37 38 30 13

Deferred revenue, non-current 3 31 31 25 11

Income taxes payable, net, non-current 931 909 936 741 323

Deferred income taxes, net, non-current 1,164 268 276 218 95

Other long-term liabilities (613) 239 246 195 85

Net cash flows from operating activities 20,434 28,084 31,517 34,777 32,388

Investing ActivitiesMarketable Securities (1,026) (1,045) (1,064) (1,083) (1,103)

Non-marketable equity securities (363) (388) (415) (381) (303)

Property and equipment (12,762) (15,665) (14,521) (13,822) (11,577)

Intangible Assets, net 577 490 417 354 301

Goodwill - - - - -

Securities lending payable (42) 472 486 385 168

Net cash flows from investing activities (13,616) (16,136) (15,097) (14,547) (12,513)

Financing ActivitiesShort-term debt (292) 580 598 473 206

Long-term debt (399) (319) (255) (204) (163)

Class A & B common stock & additional paid-in capital 1,484 4,146 4,645 5,204 5,830

Accumulated other comprehensive income - - - - -

Net cash flows from financing activities 793 4,407 4,987 5,473 5,873

Net increase (decrease) in cash & cash equivalents 7,611 16,356 21,408 25,703 25,747

Cash & cash equivalents at the beginning of year 16,549 24,160 40,516 61,924 87,626

Cash & cash equivalents at the end of the year 24,160 40,516 61,924 87,626 113,373

Alphabet, Inc.Common Size Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV 2020ERevenues 100.00% 100.00% 100.00% 100% 100% 100% 100% 100%COGS Excluding D&A 36.64% 31.38% 30.81% 32.70% 32.70% 32.70% 32.70% 32.70%

Depreciation 4.65% 5.34% 5.51% 4.71% 4.71% 4.71% 4.71% 4.71%

Amortization of Intangibles 1.94% 2.21% 1.24% 1.39% 1.39% 1.39% 1.39% 1.39%

Gross Income 56.78% 61.07% 62.44% 61.20% 61.20% 61.20% 61.20% 61.20%

Research & Development 11.93% 14.90% 16.38% 18.64% 18.64% 18.64% 19.39% 21.52%

Other SG&A Expense 18.36% 21.18% 20.25% 20.00% 20.00% 20.00% 20.00% 20.00%

Total operating expenses 30.29% 36.08% 36.63% 38.64% 38.64% 38.64% 39.39% 41.52%

EBIT (Operating Income) 26.48% 24.99% 25.82% 22.56% 22.56% 22.56% 21.81% 19.68%

Interest Income 1.31% 1.13% 1.33% 1.93% 1.93% 1.93% 1.93% 1.93%

Interest Expense -0.14% -0.15% -0.14% -0.12% -0.10% -0.09% -0.08% -0.08%

Gains (losses) on investments and securities 0.34% 0.47% -0.45% 0.50% 0.50% 0.50% 0.50% 0.50%

Impairment of equity investments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Foreign exchange gains (losses) -0.63% -0.61% -0.56% -0.70% -0.70% -0.70% -0.70% -0.70%

Gain (loss) on divestiture of business -0.10% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Other income (expense) 0.11% 0.12% 0.20% 0.80% 0.90% 1.00% 1.00% 1.00%

Pretax income 27.37% 25.96% 26.21% 24.97% 25.09% 25.20% 24.46% 22.33%

Income Taxes 4.68% 5.05% 4.40% 6.69% 6.69% 6.69% 6.69% 6.69%

Net Income 22.69% 20.91% 21.80% 18.28% 18.40% 18.51% 17.77% 15.64%

Alphabet, Inc.Common Size Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV 2020EAssetsCash and Cash Equivalents 31.59% 27.80% 22.07% 26.76% 37.46% 48.93% 62.09% 76.88%

Marketable Securities 66.56% 69.77% 75.37% 63.73% 54.17% 47.14% 43.04% 41.93%

Accounts Receivable, Net 14.85% 14.22% 15.41% 13.05% 11.12% 9.69% 8.86% 8.65%

Inventories 0.71% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Deferred Income Taxes, net 2.55% 0.00% 0.00% 0.22% 0.22% 0.22% 0.22% 0.22%

Other Current Assets 5.57% 7.39% 7.32% 7.89% 7.89% 8.89% 8.89% 8.89%

Total Current Assets 121.83% 119.17% 120.17% 111.65% 110.85% 114.86% 123.10% 136.57%

Prepaid Revenue share, expenses and other assets, non-current 3.30% 4.83% 4.24% 4.50% 4.50% 4.50% 4.50% 4.50%

Non-marketable equity securities 3.30% 4.67% 6.91% 6.14% 5.49% 5.02% 4.77% 4.77%

Property and equipment, net 27.62% 36.19% 38.69% 40.17% 41.92% 41.20% 40.64% 40.64%

Intangible Assets, net 10.14% 6.98% 5.13% 3.62% 2.57% 1.87% 1.42% 1.16%

Goodwill 19.21% 23.63% 21.16% 17.57% 14.67% 12.54% 11.24% 10.76%

Deferred Income Taxes net, non-current 0.00% 0.27% 0.33% 0.47% 0.47% 0.47% 0.47% 0.47%

Total Assets 185.41% 195.73% 196.64% 184.12% 180.46% 180.45% 186.15% 198.87%

LiabilitiesAccounts Payable 4.10% 2.60% 2.58% 2.19% 2.19% 2.19% 2.19% 2.19%

Short-term debt 5.03% 3.04% 4.30% 3.25% 3.25% 3.25% 3.25% 3.25%

Accrued compensation & benefits 4.18% 4.65% 4.72% 4.24% 4.24% 4.24% 4.24% 4.24%

Accrued expenses & other current liabilities 6.28% 6.68% 6.36% 4.26% 4.26% 4.26% 4.26% 4.26%

Accrued revenue share 2.89% 2.96% 3.11% 3.00% 3.00% 3.00% 3.00% 3.00%

Securities lending payable 2.30% 4.21% 3.24% 2.64% 2.64% 2.64% 2.64% 2.64%

Deferred revenue 1.78% 1.14% 1.05% 1.28% 1.28% 1.28% 1.28% 1.28%

Income taxes payable, net 0.04% 0.15% 0.40% 0.21% 0.21% 0.21% 0.21% 0.21%

Total Current Liabilities 26.59% 25.42% 25.75% 21.07% 21.07% 21.07% 21.07% 21.07%

Long-term debt 3.74% 4.89% 2.66% 1.77% 1.18% 0.81% 0.58% 0.44%

Deferred revenue, non-current 0.23% 0.16% 0.20% 0.17% 0.17% 0.17% 0.17% 0.17%

Income taxes payable, net, non-current 4.41% 5.06% 4.88% 5.09% 5.09% 5.09% 5.09% 5.09%

Deferred income taxes, net, non-current 3.25% 1.15% 0.25% 1.50% 1.50% 1.50% 1.50% 1.50%

Other long-term liabilities 1.24% 1.69% 2.43% 1.34% 1.34% 1.34% 1.34% 1.34%

Total Liabilities 39.47% 38.37% 36.18% 30.93% 30.35% 29.97% 29.74% 29.61%

Class A & B common stock & additional paid-in capital 43.33% 43.59% 43.98% 38.17% 35.70% 34.18% 34.34% 36.81%

Accumulated other comprehensive income 0.21% 0.04% -2.50% -2.08% -1.73% -1.48% -1.33% -1.27%

Retained Earnings 102.40% 113.73% 118.98% 117.10% 116.15% 117.78% 123.39% 133.71%

Total Stockholders Equity 145.94% 157.36% 160.46% 153.19% 150.12% 150.48% 156.40% 169.26%

Total Liabilities and stockholders equity 185.41% 195.73% 196.64% 184.12% 180.46% 180.45% 186.15% 198.87%

Alphabet, Inc.Value Driver Estimation

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

Revenues 59,825 66,001 74,989 90,294 108,161 126,556 141,121 147,472 Less: Cost of Goods Sold 21,919 20,712 23,101 29,526 35,368 41,384 46,147 48,223 Less: R&D 7,137 9,832 12,282 16,831 20,161 23,590 27,364 31,743 Less: Depreciation 2,781 3,523 4,132 4,253 5,094 5,961 6,647 6,946 Less: Amortization of Intangibles 1,158 1,456 931 1,255 1,503 1,759 1,962 2,050 Less: SG&A 10,986 13,982 15,183 18,059 21,632 25,311 28,224 29,494 Plus: Implied Interest on Operating Lease 168 186 274 343 428 492 542 566

EBITA 16012 16682 19634 20713 24829 29043 31319 29582

Marginal Tax Rate 18.54% 23.88% 19.29% 25% 25% 25% 25% 25%

Adjusted Taxes:Income Tax Provision 2,798 3,331 3,303 6,041 7,236 8,467 9,441 9,866

Plus: Tax shield on interest expense 15 24 20 27 27 28 29 29 Less: Tax on interest income 146 178 193 436 522 611 681 712 Less: Tax on Investment Gains 37 74 - 113 135 158 176 184 Plus: Tax Shield on Investment Losses - - 64 - - - - - Plus: Tax Shield on Loss on Divestitures 11 - - - - - - - Less: Tax on Other Income 12 20 29 181 243 316 353 369 Plus: Tax shield on Operating Lease Interest 31 44 53 86 107 123 135 141 Plus: Tax shield on Foreign Exchange Losses 70 96 81 158 189 221 247 258

Total Adjusted Taxes 2,730 3,223 3,300 5,582 6,659 7,754 8,642 9,030

Deferred Tax Liability 2,424 2,645 6,076 7,428.66 7,696.31 7,971.88 8,190.08 8,285.21

Deferred Tax Asset 2,067 2,063 6,138 6,560.24 6,643.79 6,729.82 6,797.93 6,827.62

Net Deferred Taxes 357 582 (62) 868 1,053 1,242 1,392 1,458 Change in Deferred Taxes (371) 225 (644) 930 184 190 150 65

NOPLAT 12,911 13,684 15,690 16,061 18,354 21,479 22,827 20,617

Invested CapitalOperating Current Assets:

Normal Cash 13,203 14,566 16,550 19,928 23,871 27,931 31,146 32,547 Accounts Receivable 8,882 9,383 11,556 11,787 12,023 12,263 12,509 12,759 Inventory 426 - - - - - - - Other Current operating assets 3,335 4,878 5,492 7,124 8,534 11,251 12,546 13,111

Current Operating Assets 25,846 28,827 33,598 38,839 44,428 51,445 56,200 58,416

Non-Interest Bearing Current Liabilities:Accounts Payable 2,453 1,715 1,931 1,978 2,369 2,772 3,091 3,230 Accrued Expenses 3,755 4,408 4,768 3,849 4,610 5,395 6,015 6,286 Accrued Revenue Share 1,729 1,952 2,329 2,709 3,245 3,797 4,234 4,424 Accrued Compensation & Benefits 2,502 3,069 3,539 3,825 4,582 5,361 5,978 6,247

Deferred Revenue 1,062 752 788 1,156 1,385 1,621 1,807 1,889 Income Taxes Payable 24 96 302 188 226 264 294 308

Current Operating Liabilities 11,525 11,992 13,657 13,705 16,417 19,209 21,419 22,383

Net Operating Working Capital 14,321 16,835 19,941 25,135 28,011 32,237 34,781 36,033 Plus: Net PP&E 16,524 23,883 29,016 36,270 45,338 52,138 57,352 59,933 Plus: Net Other Operating Assets 6,066 4,607 3,847 3,270 2,779 2,363 2,008 1,707 Less: Other Operating Liabilities 139 104 151 154 185 216 241 252 Plus: PV of Operating Leases 3,104 4,570 5,479 6,465 7,628 8,696 9,566 9,996 Less: L-T Income Taxes Payable (non-deferred) 2,638 3,340 3,663 4,594 5,503 6,439 7,180 7,503

Invested Capital 37,239 46,451 54,469 66,391 78,069 88,778 96,285 99,914

Core Value DriversNOPLAT 12,911 13,684 15,690 16,061 18,354 21,479 22,827 20,617 Beginning Invested Capital 32,169 37,239 46,451 54,469 66,391 78,069 88,778 96,285 Return on Invested Capital (ROIC) 40.13% 36.75% 33.78% 29.49% 27.65% 27.51% 25.71% 21.41%

NOPLAT 12,911 13,684 15,690 16,061 18,354 21,479 22,827 20,617 Less: Change in Invested Capital 9,893 5,070 9,213 11,922 11,678 10,710 7,507 3,629 Free Cash Flow (FCF) 3,018 8,614 6,478 4,139 6,676 10,769 15,320 16,988

NOPLAT 12,911 13,684 15,690 16,061 18,354 21,479 22,827 20,617 Beginning Invested Capital 32,169 37,239 46,451 54,469 66,391 78,069 88,778 96,285 ROIC 40.13% 36.75% 33.78% 29.49% 27.65% 27.51% 25.71% 21.4121%WACC 6.92% 6.92% 6.92% 6.92% 6.92% 6.92% 6.92% 6.92%Economic Profit (EP) 10,684 11,106 12,475 12,291 13,759 16,075 16,682 13,952

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

Cost of Equity Beta Monthly Returns: 2000 - 2015Risk Free Rate 2.70%Market Risk Premium 4.00%Beta 1.079Cost of Equity 7.02%

Cost of DebtPre-tax Cost of Debt 2.88%Tax Rate 19.29%After Tax Cost of Debt 2.32%

Capital Structure WeightsShares Outstanding 687.35Current Price $759.39Market Value of Equity 521,967

LT Debt 1995ST Debt 3225PV of Operating Leases 5479Book Value of Debt 10,699

Total Firm Value (E+D) 532,665

Weighted Average Cost of Capital 6.92%

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

Key Inputs: CV Growth 4.50% CV ROIC 21.41% WACC 6.92% Cost of Equity 7.02%

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

DCF ModelFree Cash Flow 6,478 4,139 6,676 10,769 15,320 16,988 30,927 Continuing Value (CV) 672,397 WACC 6.92%CF to Discount 4,139 6,676 10,769 15,320 672,397 Period 1 2 3 4 4PV (CF) 3,871 5,840 8,810 11,722 514,472

Value of Operating Assets 544,715$ Add: Excess Cash -Add: Short-term marketable securities 56,517 Less: Short-term debt 3,225 Less: Long-term debt 1,995 Less: PV of Operating Leases 5,479 Less: PV of ESOP 10,451 Value of Equity 580,083 Shares Outstanding 687Intrinsic Value of Stock 843.94$

EP ModelEconomic Profit 12475 12291 13759 16075 16682 13952 23105Continuing Value 576112Beginning Invested Capital 54,469 WACC 6.92%EP to Discount 12291 13759 16075 16682 576112Period to Discount 1 2 3 4 4PV (EP) 11496 12035 13151 12764 440801

Value of Operating Assets 544,715$ Add: Excess Cash -Add: Short-term marketable securities 56,517 Less: Short-term debt 3,225 Less: Long-term debt 1,995 Less: PV of Operating Leases 5,479 Less: PV of ESOP 10,451 Value of Equity 580,083 Shares Outstanding 687Intrinsic Value of Stock 843.94$

Today 4/19/2016Next FYE 12/31/2016Last FYE 12/31/2015Days in FY 366 Days to FYE 110 Elapsed Fraction 0.301Adjusted Stock Price 861.32

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

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

EPS 23.66$ 28.09$ 32.58$ 34.36$ 31.14$ Growth -0.5% 19% 16% 5% -9%Key Assumptions CV growth 4.50% Payout Ratio (Industry Avg.) 1.29% CV ROE 9.24% Dividend Yield (Industy Avg.) 0.02% Cost of Equity 7.02%

Future Cash Flows P/E Multiple (CV Year) 20.38 EPS (CV Year) 31.14$ Future Stock Price 634.74$ Dividends Per Share 0.31$ 0.36$ 0.42$ 0.44$ 0.40$ Discount Period 1 2 3 4 4 Discounted Cash Flows 0.29$ 0.32$ 0.34$ 0.34$ 484.25$

Intrinsic Value 485.54$ Adjusted Price 495.38$

Alphabet, Inc.Relative Valuation Models

EPS EPS Est. 5yrTicker Company Price 2016E 2017E P/E 16 P/E 17 EPS gr. PEG 16 PEG 17AAPL Apple $109.58 $9.22 $9.09 11.9 12.1 33.6 0.35 0.36 TWTR Twitter $17.58 $0.55 $0.76 32.0 23.1 41.40 0.77 0.56 BIDU Baidu $189.81 $15.26 $6.80 12.4 27.9 57.4 0.22 0.49 FB Facebook $116.13 $2.28 $3.14 50.9 37.0 37.4 1.36 0.99

Average 26.8 25.0 0.7 0.6

GOOGL Alphabet, Inc. $759.39 23.78 23.66 31.9 32.1 15.5 2.1 2.1

Implied Value: Relative P/E (EPS15) $ 637.76 Relative P/E (EPS16) 591.81$ PEG Ratio (EPS15) 249.67$ PEG Ratio (EPS16) 219.60$

Alphabet, Inc.Key Management Ratios

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

Liquidity RatiosCurrent Ratio (Current Assets/Current Liabilities) 4.58 4.69 4.67 5.30 5.26 5.45 5.84 6.48Quick Ratio (Current Assets - Inventory)/Current Liabilities 4.55 4.69 4.67 5.30 5.26 5.45 5.84 6.48Operating Cash Flow Ratio (Operating CF/Current Liabilities) 0.19 0.51 0.34 0.22 0.29 0.40 0.52 0.55

Activity or Asset-Management RatiosInventory Turnover (COGS/ Average Inventory) 43.40 48.62 N/A N/A N/A N/A N/A N/AReceivable Turnover (Revenues/ Accounts Receivable) 6.74 7.03 6.49 7.66 9.00 10.32 11.28 11.56Total Asset Turnover (Revenues/ Average Total Assets) 3.49 3.61 4.10 4.80 3.74 3.81 4.11 4.82

Financial Leverage RatiosDebt/Equity (Total Liabilities/ Total Shareholders' Equity) 27.04% 24.39% 22.55% 20.19% 20.21% 19.92% 19.02% 17.49%Debt Ratio (Total Liabilities/Total Assets) 21.29% 19.60% 18.40% 16.80% 16.82% 16.61% 15.98% 14.89%Equity Ratio (Shareholders' equity/Total Assets) 78.71% 80.40% 81.60% 83.20% 83.18% 83.39% 84.02% 85.11%

Profitability RatiosGross Margin (Revenues-COGS)/ Revenue 63.36% 68.62% 69.19% 67.30% 67.30% 67.30% 67.30% 67.30%Operating Margin (Operating Income/Total Revenue) 26.48% 24.99% 25.82% 22.56% 22.56% 22.56% 21.81% 19.68%Net Profit Margin (Net Income/ Revenue) 22.69% 20.91% 21.80% 18.28% 18.40% 18.51% 17.77% 15.64%Return on Assets (Net Income/ Total Assets) 12.24% 10.68% 11.09% 9.93% 10.20% 10.26% 9.55% 7.86%Return on Equity (Net Income/ Total Shareholders' Equity 3.45% 1.93% 2.68% 2.12% 2.16% 2.16% 2.08% 1.92%Payout Policy RatiosDividend Payout Ratio (Dividend per share/EPS) N/A N/A N/A N/A N/A N/A N/A N/A

Present Value of Operating Lease Obligations 2009 Present Value of Operating Lease Obligations 2010

Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases2010 310 2011 3232011 296 2012 3192012 276 2013 2792013 237 2014 2232014 188 2015 189Thereafter 1237 Thereafter 1058Total Minimum Payments 2544 Total Minimum Payments 2391Less: Interest 370 Less: Interest 320PV of Minimum Payments 2174 PV of Minimum Payments 2071

Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 2.88% Pre-Tax Cost of Debt 2.88%Number Years Implied by Year 6 Payment 6.6 Number Years Implied by Year 6 Payment 5.6

Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment1 310 301.3 1 323 314.02 296 279.7 2 319 301.43 276 253.5 3 279 256.24 237 211.6 4 223 199.15 188 163.1 5 189 164.06 & beyond 188 965.2 6 & beyond 189 836.7PV of Minimum Payments 2174.3 PV of Minimum Payments 2071.4

Present Value of Operating Lease Obligations 2011 Present Value of Operating Lease Obligations 2015

Operating OperatingFiscal Year's Ending Leases Fiscal Years Ending Dec. 31 Leases2012 389 2016 6722013 377 2017 7942014 357 2018 7962015 311 2019 7692016 256 2020 719Thereafter 1264 Thereafter 3706Total Minimum Payments 2954 Total Minimum Payments 7456Less: Interest 383 Less: Interest 1062PV of Minimum Payments 2571 PV of Minimum Payments 6394

Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 2.88% Pre-Tax Cost of Debt 2.88%Number Years Implied by Year 6 P 4.9 Number Years Implied by Year 6 P 5.2

Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment1 389 378.1 1 672 653.22 377 356.2 2 794 750.23 357 327.9 3 796 731.04 311 277.6 4 769 686.45 256 222.1 5 719 623.86 & beyond 256 1008.8 6 & beyond 719 2949.0PV of Minimum Payments 2570.7 PV of Minimum Payments 6393.7

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 31Average Time to Maturity (years): 2.86Expected Annual Number of Options Exercised: 11

Current Average Strike Price: 482.03$ Cost of Equity: 0.00%Current Stock Price: $759.39

2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025EIncrease in Shares Outstanding: 11 11 11 11 11 11 11 11 11 11Average Strike Price: 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ 482.03$ Increase in Common Stock Account: 5,157 5,157 5,157 5,157 5,157 5,157 5,157 5,157 5,157 5,157

Change in Treasury Stock 0 0 0 0 0 0 0 0 0 0Expected Price of Repurchased Shares: 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ 759.39$ Number of Shares Repurchased: - - - - - - - - - -

Shares Outstanding (beginning of the year) 687 698 708 719 730 741 751 762 773 784Plus: Shares Issued Through ESOP 11 11 11 11 11 11 11 11 11 11Less: Shares Repurchased in Treasury - - - - - - - - - - Shares Outstanding (end of the year) 698 709 719 730 741 751 762 773 784 795

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol GOOGLCurrent Stock Price $759.39Risk Free Rate 0.00%Current Dividend Yield 0.00%Annualized St. Dev. of Stock Returns 38.80%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedESOs 4.9 221.31 3.70 544.05$ 2,665$ RSUs 25.7 531.74 2.70 298.74$ 7,690$ Total 31 376.53$ 0.21 382.87$ 10,355$