Why Is Google Buying Nest?

It was just one week ago when the big news was announced: Google Acquires Nest for $3.2 billion.
For many investors, it was just the latest multi-billion dollar merger and acquisition in Silicon Valley.  With companies flush with cash and share prices at all-time highs, it’s been a good time to make acquisitions.
Google (NASDAQ: GOOG) surprised many observers when it announced the acquisition of a little-known company called Nest for $3.2 billion.  That marks the second largest acquisition in Google’s history, following its 2011 buyout of Motorola Mobility for $12.5 billion.
In the wake of the acquisition, some Google investors may be asking, “What is Nest?  And why is Google buying it?”
Simply put, Nest is a tech company that created “smart” thermostats and smoke detectors.  What that means is that these devices react to people’s habits, and adjust automatically.  For example, your Nest thermostat will learn that you wake up at 6:30am and turn up the temperature in the downstairs of your home from 64 degrees to 70 degrees.  And a result, it will automatically begin making this daily adjustment.
Additionally, Nest devices can be controlled and monitored remotely via an app on a Google Android or an Apple (NASDAQ: AAPL) iPhone.  This allows you to change settings and monitor your home.
The selling proposition of Nest is partially the cool factor of having the latest and greatest device.  But Nest also makes homes more efficient, and can create real cost savings.  According to Nest, I could save $207 – $815 per year on my electric and propane gas bill if I upgraded my thermostats.
Google wants to own Nest because the acquisition gives the company a direct connection to home appliances.  After all, Google is already in the business of search, video, email broadband, and smartphones.  Nest allows Google to leverage its existing platforms to control smart appliances.
One year ago, Nest had raised $80 million in equity, including an investment from Google Ventures.  The company has been getting great traction.  Research firm Gigaom reported that one year ago, Nest was selling 40,000 – 50,000 thermostats per month.
Morgan Stanley analyst Scott Devitt estimates that this has now grown to 100,000 units per month.  With a sale price of $250, that translates into annual revenues of about  $300 million.
Earlier this year, it was rumored that Nest was on the verge of raising $150 million at a $2 billion valuation.  It was reported that Russian billionaire Yuri Milner’s DST Global – which made billions by investing in Facebook (NASDAQ: FB) in 2009 – was going to lead the round.
However, Google caught wind of the deal and decided to simply buy the entire company for more than $3 billion.  If the Morgan Stanley estimates are accurate, that means that Google is paying about 10-times sales for Nest.
But the opportunity for Google is much, much larger than the Nest business today.  The acquisition firmly places Google in a strong position to bring its data expertise and dominance to the home.
While the $3.2 billion price tag is hefty, it’s affordable for Google.  After all, Google has about $47 billion in net cash on its balance sheet.  In the last quarter, Google earned $5 billion in cash flow from operations.  That means that the company spent just two months of its cash flow to purchase a business that could be a huge growth engine for the company over the next decade.
Google shares have risen sharply in recent months.  After treading water at $500 – $600 per share from 2010 – 2012, Google stock soared 62% in the last year.  With shares at $1,156, the stock is trading at an all-time high.
With smart acquisitions like Nest, Google should be able to grow its business rapidly for years to come.  That’s one of the reasons why I own the stock in my $100k Portfolio.  I continue to believe that this is one stock that every investor should buy and hold for the long-term.
Even after the big jump for Google shares in 2013, the stock trades at a valuation of 22-times this year’s earnings.  That’s a premium price to the S&P 500 index, but a bargain among innovative tech stocks.

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