Why Did Google Overpay For Its Second-Largest Acquisition?

Why Did Google Overpay For Its Second-Largest Acquisition?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The U.S. Congress has agreed a broad $1 trillion spending deal for the first time since 2009, heading off the possibility of another government shutdown. Coming on the back of a rough start to the week for stocks, that ought to give investors something to cheer about. The S&P 500 and the narrower Dow Jones Industrial Average are up 0.43% and 0.26%, respectively, at 10:15 a.m. EST.

Google is a corporate iconoclast. What other explanation could there be for a $3.2 billion acquisition -- its second largest ever -- in an area that appears completely unrelated to its core activity? Furthermore, the price looks very rich indeed, which suggests that the search giant was well motivated to complete the deal.

The target? Nest Labs, which produces "smart" thermostats and smoke alarms for the home. For example, users can control the Nest Themostat from their mobile devices; in addition, it learns to recognize usage patterns and can change its own settings on that basis.

That sounds handy enough, but does it justify a multibillion-dollar buyout for a company that has not yet celebrated its fifth birthday? As FT Alphaville pointed out, under the most optimistic sales forecasts, Google is paying nearly 13 times revenue for Nest -- that's the high heat setting on the M&A thermostat. In a venture financing round early last year (in which Google Ventures participated), the company was valued at just $800 million.

Still, the company has an impressive pedigree: founders Tony Fadell and Matt Rogers are Apple alumni; Fadell was a designer on the iPod and the iPhone, while Rogers was a hardware engineer on both products. Apple's object lesson that design is an important differentiator in consumer electronics was not lost on the pair: Nest's products cultivate a minimalist look that is reminiscent of Apple devices. iThermostat, anyone?

One can argue the price, but in the wake of last week's massive 2014 Consumer Electronics Show in Las Vegas, Google looks to have stolen a stride from some of its rivals and partners with this deal. Indeed, the so-called "Internet of Things," in which ordinary household appliances such as refrigerators and -- yes -- thermostats are accessible via the Internet, was arguably the emerging theme of this year's show. Samsung, for example, launched a "smart home" initiative to showcase the connectivity between its various devices and appliances.

What does this have to do with online search and advertizing, you might ask? Nothing, at first glance, although it could be a profitable sideline. However, I suspect the acquisition is more strategic than that. Nest may ultimately provide Google with more insight into how its customers live and spend their time -- which is another piece of the puzzle when it comes to building a consumer profile.

Act now: This is the one stock you must own for 2014
There's a huge difference between a good stock, and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

The article Why Did Google Overpay For Its Second-Largest Acquisition? originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Originally published