Alphabet Could Benefit From Large Acquisitions Over the Next 2 Years

• Alphabet (GOOG, GOOGL) has finally decided to spend some of its huge $140 billion cash and securities pile
• It has made a small $5.4 billion of Mandiant (MNDT), which is seen as complementary to the company’s operations
• It may now use its cash for more than just share repurchases, which used up 75% of its $67 billion in FCF last year

On March 8, Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) announced a purchase of Mandiant (NASDAQ:MNDT) at $23 per share. The deal will cost $5.4 billion in cash according to a definitive agreement with the company. If Alphabet can maintain this kind of activity, analysts and the market might view this as a catalyst that could push GOOG stock higher.

According to Bloomberg, this “small” $5.4 billion acquisition, is still the second-largest in its history. In 2012 it bought Motorola for $12.5 billion, but that never turned into a major earnings contributor for the company. It later sold the company to Lenovo for $2.91 billion in 2014, a major loss. That probably cooled the company from making large acquisitions for a long time.

However, since then its competitor Microsoft (NASDAQ:MSFT) bought LinkedIn for $26.2 billion in cash in 2016. It also recently made an all-cash acquisition offer for Activision Blizzard (NASDAQ:ATVI) for $68.7 billion. The LinkedIn acquisition is generally seen as a major success for Microsoft, as will the Activision Blizzard acquisition. In 0ther words, Google may be getting left behind, at least in investors’ minds. Alphabet sees this and realizes that it may have to use its cash flow for more than just share repurchases.

Google’s Massive Share Repurchases

Last year Alphabet bought back $50.3 billion 0f its shares, representing 75% of its $67.0 billion of free cash flow (FCF) and almost 20% (19.5%) of its $257.6 billion in revenue in 2021.

When Alphabet announces its first-quarter earnings on April 26, investors will be looking to see how much it is spending on share repurchases. Last quarter, the company produced $18.55 billion in FCF (as seen on page 7 of its earnings release).

It bought back $13.473 billion in stock during the quarter, as seen on page 6 under the line “Repurchases of common and capital stock.” That used up 72.6% of its FCF. It made just $385 million in acquisitions, less than 2% of its FCF during the quarter. The rest of the FCF was spent on debt repayments and payments for stock-based awards.

The huge portion of its FCF spent on buybacks might be seen as politically unpalatable by some. For example, the New York Times reported recently that taxing buybacks might be a way for the government to raise tax revenue.

However, buybacks for large companies like Alphabet allow the company to reduce its share count, increasing its earnings per share. It also helps push up the stock price to higher valuation metrics. In effect, it is a return of capital to shareholders and is much more tax-efficient than paying out a dividend to investors.

Why GOOG Stock Could Rise

Analysts forecast that revenue this year will rise to $303.76 billion in this year and $351.2 billion in 2023, according to analyst surveys taken by Refinitiv (Yahoo! Finance). That is up 17.9% this year from the $257.6 billion in sales it made last year. By 2023, revenue will be almost $100 billion higher, or 36.3% more revenue than in 2021.

This implies that Alphabet’s free cash flow is set to explode. For example, in 2021, its $67 billion in FCF represented 26% of its $257.6 billion in revenue. In Q4 the FCF margin was 24.6%. So, let’s assume that one-quarter of revenue in 2022 and 2023 will become free cash flow.

That implies that by 2023 its FCF will be as large as $88 billion (i.e., 0.25 x $351b). This is $20.75 greater than the $67 billion the company generated in 2021. If Alphabet spends three-quarters of that amount on buybacks, it will be spending $65.8 billion in share repurchases. That is a massive amount of buybacks, representing 3.89% of its $1.689 trillion market value today.

Therefore, it seems logical that the company will turn to acquisitions for a larger portion of this FCF to help develop its market value going forward. Expect to see GOOG stock benefit from these acquisitions as well as its huge share buybacks over the next two years.

On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.