We recalibrate our model to reflect greater contribution from YouTube while moderating near-term Play estimates. We increase our target price to $700 (vs. $690 prior), but our adj. EPS for FY15 comes down by 200bps, to $25.88 (vs. $26.40 prior), as we modestly decrease our near-term revenue and gross profit forecasts.
Investment Case: We believe the aggregated revenue contribution from YouTube AND Google Play has risen from 4% of Gross Revenue in 2010 to 15% in 2015 and should reach 24% by 2020, given the higher trajectory of growth versus core search. And as these businesses continue to scale, they should both see gross margin expansion which should underpin near-to-medium-term operating margin stabilization and eventually to margin expansion. Following extensive checks with industry sources, we have recalibrated our model to assume a steeper gross profit dollar growth trajectory for YouTube as improved monetization via TrueView is set to drive net revenue (ex-CAC) growth in excess of bandwidth costs which we believe is more tethered to the growth of consumer engagement. As for Play we believe that Google is on the cusp of significantly surpassing revenue guarantees offered to its telco distribution partners and is hence also set to show greater operating and free cash flow contribution.
Changes to Estimates: We decrease our FY15 net revenue forecast by 50bps as we moderate our near-term forecast for Google Play following recent weakness as a result of exposure to regions impacted by FX.
Valuation: Our DCF-derived target price, which uses a 10.5% weighted average cost of capital and 3% terminal growth rate, increases to $700.
Rating: Googl: OUTPERFORM
Target price (US$): (from 690.00) 700.00