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By Shannon Zimmerman | 05-08-2013 12:00 PM

BBH's Core Focus on Google

By homing in on Google's core revenue-generating operations, BBH manager Tim Hartch sees a value proposition in the online firm, with Google's other investments being gravy.

Shannon Zimmerman: So let's talk a little bit about your approach both at Core Select and the new fund, Global Core Select. In some ways, it's a nontraditional value approach, to the extent that folks are looking at value, and saying, "Oh, these are the sectors that value investors typically favor. This is the price/earnings ratio that a value investor is going to be attracted to." That's not really your style. You're really an absolute value shop, and you are looking at the discount between what you think a company is worth--it's intrinsic value--and what the market has priced it at. So in some ways, that kind of explains my next question I think, what's a company like Google doing in a portfolio like this?

Tim Hartch: Well, we think Google is a great fit. In fact, it's a top-five position in both of our two portfolios. So we believe it has a fabulous culture, it has a very good management team, it has a dominant position in search, a very strong, obviously, position with Android, and a lot of innovative technology and opportunities going for it. And it's a very cash-generative business with a great balance sheet.

So we think it's a very good fit with virtually all of our criteria. We look for recurring revenues often, for loyal customer base, and for essential products and services. We look for very strong competitive position, leadership, and an attractive industry niche. And when you look at Google's business, it is an advertising-driven business, but they really do have, with their search and return on investment, they really provide incredible value. And it's hard for their customers to go anywhere else.

So we're very excited to have Google in the portfolio at a time when it's hard to find high-growth businesses, and this is a business that's very cash-generative and still growing. In the most recent quarter, their revenue is at a 20%-plus rate, the core Google business.

Zimmerman: And a value stock, apparently, right? So to make it into your portfolio, it has to be at least a 25% discount to your estimate of intrinsic value, and then you let it run up to what you think of as its fair value. So it's in the top five of Core Select. How deep is the discount now would you say?

Hartch: It's in the 80% range.

Zimmerman: And then, let me draw you out a little more on the particulars of Google just in a kind of contrarian way. So you mentioned it's an advertising-driven business, and it sure is. About 98% of revenue, last time I looked, was coming from advertising for Google, and there was a lot of unrealized potential in terms of things that they could monetize, technology that they're working on. What's the second act? When do we get to the point where we say, "Oh, Google is able to monetize some of these nifty things they've been working on over so long?"

Hartch: Well, I'll answer the question, but I think the key point is that their search business, which is where they make most of their money today, is going to continue to grow. Their share over online advertising is high and actually growing, and online advertising is growing. If you look at the amount of dollars in that online advertising versus the amount of time people spend online, it's underrepresented and underweighted. So there will still to be more money flowing into online advertising.

Zimmerman: Flowing into that business.

Hartch: Yes. So you don't have to put a lot, and that's something we like as investors. We like to make investments, be able to value a core business, and have some very interesting options that could be significant, but not really have to pay for that. We have other investments like Celanese, which is a company that we own in Core Select. It's a specialty chemicals business where they have some ethanol technology that is potentially transformative, but we're not valuing it today. So, if you can buy that free option it's great.

There are a lot of investments that Google's made that potentially could be significant. I don't want to try to predict when they are going to bear fruit, but whether its Voice Search or whether its Android or some of the more exotic investments they have.

Zimmerman: Google Glass.

Hartch: Yeah, Google Glass; I haven't tried it yet. These are potentially significant opportunities, but you have to recognize some of them will fail, and we're basing our valuation on the core business and the other is extra.

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