Google (GOOG +0.56%) shares rose 2.7%, just days after the company announced its purchase of Nest for $3.2 billion on January 13. The all-cash transaction gives Google a solid footing in the emerging Internet of Things industry. The rise in the company's share price is an indication that many investors liked this new acquisition.
Nest Labs was founded in 2011, but it is already enjoying great success from its Smart, self-learning thermostat. Google's investment arm, Google Ventures, was one of the early backers of this start-up company formed by former Apple engineers, Tony Fadell and Matt Rogers.
Why did Google buy Nest?
The sleek Apple-like aesthetics and advanced self-learning algorithm of the Nest Thermostat was a big hit with customers. The device helped users save 5%-60% on their home electricity bills. The thermostat's sensors make it very effective at maximizing energy efficiency in the household. It learns from the habits and preferences of occupants, detects weather changes, and knows whether a house is occupied or not.
Morgan Stanley analyst Scott Devitt estimates that Nest has been selling approximately 100,000 thermostats per month. Each thermostat sells for $250, so Nest's 2014 revenue can be pegged at $300 million. The company also started selling a smart smoke and carbon monoxide detector, called Protect, last November. The Nest Protect retails for $129. Both products are intelligent, persistent data-gathering devices that learn from the people around it. Nest products are self-aware and can communicate with each other, too.
The technology behind Nest's products is very desirable because it enables ordinary devices to become smart data-collecting agents. The $3.2 billion payment is approximately 10 times Nest's projected 2014 revenue, so Google did buy the company at a fair price. The company will allow Google even entry deeper into the household.
Google will likely use Nest's technology to create more smart appliances as a way to gather more in-depth personal data and preferences for its core advertising business. It also doesn't hurt that the search giant gets a new revenue stream from selling Internet of Things devices. This new growth industry for smart and connected appliances is predicted by IDC to become a mammoth $8.9 trillion business by 2020.
Google is already working on another Internet of Things product; The smart contact lens is intended to help diabetics monitor their blood-sugar level. This is further evidence that the company is really serious about its intention to become a leader in smart devices.
Google also received a new price target
The positive market reaction toward the Nest acquisition is also in line with the new endorsement from Raymond James analyst Aaron Kessler. Kessler upgraded his target price for Google from $1,030 to $1,260 due to healthy estimates of the company's Q4 2013 earnings. The analyst cited increases in search spending and a 14% year-over-year increase in gross advertising income as main reasons for Google's upgrade.
Conclusion
Google would be a great addition to your portfolio. The long-term benefit of the Nest acquisition is plain to see: Google's core advertising cash cow is further strengthened by Nest's technology and patents. The lucrative targeted advertising business requires more in-depth profiling of people and their habits.
Nest's technology gives Google access to consumers' behavior while they are relaxing, playing, sleeping, and eating inside the comfort of their homes. Google doesn't have to rely solely on computers and smartphones to gather data anymore. Future models of the Nest Thermostat will most likely be able discretely track and record behavioral patterns of individuals in the house.
The Raymond James price target is also 8.97% higher than Google's current price. If Google beats the Street estimates on January 30, Kessler's guidance may come true, as he maintained an "outperform" rating for Google.
