UBS analysts Eric J. Sheridan, Vishal J. Patel and Timothy E. Chiodo rate Google Inc (NASDAQ:GOOG) as a Buy based on the increasing exposure to the “internet of things”.

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Google announces acquisition of Nest Labs

Today after the market close, Google Inc (NASDAQ:GOOG) announced it has agreed to acquire Nest Labs, a developer/manufacturer of digitally-connected home products whose current lineup includes the Nest Thermostat & Nest Protect (smoke & carbon monoxide alarm).  After the deal, Nest will continue to operate separately under the leadership of Tony Fadell, CEO & Co-Founder (former SVP of iPod division at Apple).  The $3.2b deal is pending regulatory approval and is expected to close in the next few months. Given the lack of public financials, it is too early to determine the financial impact over the medium term.  We note that Nest was already among the Consumer holdings in the Google Ventures portfolio (% stake not disclosed), which may result in lower cash consideration.

Google pursuing an innovation agenda

As highlighted in our Jan. 6th deep-dive (“The Innovation Leader”), we believe Google is increasingly pursuing an innovation agenda in three key areas outside of its traditional personal computing domain: the Home, the Car, & the Workplace.  Coupled with its operating system investments (Android/Chrome) & devices like Chromecast, the acquisition of Nest bolsters Google Inc (NASDAQ:GOOG)’s efforts to bring its platform into the Home as it competes for greater consumer mind/walletshare vs. other platforms (e.g., Apple, Microsoft & Amazon).  Furthermore, we believe this deal highlights a growing trend – large-cap tech companies are increasingly buying smaller, emerging companies to extend their overall platforms, which might have otherwise been disruptive in the broader tech ecosystem (e.g., Google’s 2013 acquisition of Waze).

Potential for increased cash returns

In our Jan. 6th report, we cited the potential for increased cash returns given continued growth in Google Inc (NASDAQ:GOOG)’s cash balance.  Importantly, today’s announcement does not change our view – Google ended Q3 ’13 with $56.5b in cash & ST investments (~$24.3b domestic) and is expected to generate $86b in FCF from 2014-17 based on our ests.

Our $1,300 PT is based on our weighted avg. approach (EV/Sales, EV/EBITDA, EV/FCF).