GOOG is value hiding in plain sight, but with no immediate catalyst.

GOOG is attractively priced: you pay 12.5X EBIT (first quarter annualized) and you get a company that: 1) is growing top line +27%, 2) has significant operating leverage over time and 33% EBIT margins today, 3) converts 100% of earnings into cash and generates more than 100% ROIC. The company is conservatively financed with net cash and investments representing about 20% of the market cap. They'll make $30ish this year and maybe $40-45 in 2013. Cash will probably grow from about $100 per share today to near $200 at year end 2013. It's not a stretch to think the stock could get to $875 or more in 2-3 years.

You get one hell of a business in Google Search, the dominant search engine in most markets outside of China. Let's apply Buffett's definition of a wide moat to GOOG: can we kill Search with a few billion dollars? Microsoft gives us a clue; in their Online Services Division they lost $1.8B in the 9 months ending 3/31/11 on $1.9B in revenue. That's no typo, they're running their search business with a negative 98% operating margin (to be fair this includes MSN and other online services as well). Since the re-launch of Bing, Google's search share has held steady and MSFT has not generated a profit. Do you remember when MSFT tried to pay people to use their search engine? That didn't work either. Moat? Check.

You also get two platforms that could become huge: YouTube and Android. Both are the market leaders in two of the most important growth areas for tech: internet/mobile video and smart phones. And finally, you get an amazing engineering culture of 26k working hard to improve the existing business and to find new $1B businesses.

In terms of recent business performance, in the first quarter, Search got a nice boost from both paid clicks (+18%) and cost per click (+8%). There is still a lot of room to run. Per PwC and the IAB, in 2010 US TV advertising was $68.7B while internet advertising was $26B (GOOG has 54% market share of US internet advertising). Over time I would expect the internet to eclipse TV advertising, but this is a speculative guess. The problem with the first quarter was the expense line. On the one hand, Google is quite undisciplined about spending and quarterly budgets so the expense line blows them up on occasion. On the other hand, they've done okay with this strategy over the long-run and I do like that they pay little attention to the demands of Wall Street.

There are three primary risks to Google as I see it: the development of a more curated web, Facebook and Larry Page. Google is most helpful with an internet like the Wild West with information users are seeking in the nooks and crannies of the web. I worry we're moving toward a more curated internet with "apps" that let users easily access exactly what they're looking for without using Search. Second, Facebook knows an amazing amount about their 600M users and they are very sticky (very strong network effect business model). This is EXTREMELY valuable to advertisers. For the Liberty junkies you'll note as I have that Facebook has become the largest source of traffic for QVC.com. Last, it is definitely possible that Larry Page is the "arrogant prick" Wall Street thinks he is and that he will waste away the company's assets.

I am not much concerned about government inquiries in the US or EU because Google has created a natural monopoly by developing a superior product. Searchers use Google because it provides the most relevant information, quickly. Advertisers use Google because it generates a measurable return on their ad dollars. As far as I can tell, the only people complaining about Google are their competitors.

Make sure you read the following:
http://investor.google.com/corporate/founders-letter.html
http://investor.google.com/documents/20101231_google_10K.html
http://www.amazon.com/Plex-Google-Thinks-Works-Shapes/dp/1416596585
http://www.iab.net/about_the_iab/recent_press_releases/press_release_archive/press_release/pr-052611
http://www.iab.net/media/file/IAB_AR11_final.pdf
http://www.iab.net/media/file/IAB_Full_year_2010_0413_Final.pdf

Market cap: $171,556M (326.4M shares, $525.60 stock price)
Cash, equivalents & short-term marketable securities: $36,675M
Repo receivables: $575M
Debt: $3,216M
Sec lending payables: $1,880M
DOJ investigation accrual: $500M
EV: $139,902M
Q1 EBIT: $2,796M
EV/EBIT: 12.5X