Column: Google wows the crowd

by Mathew on October 21, 2005

Here’s a column I posted at globeandmail.com on Google’s quarterly results:

“First things first: Anyone who wishes they had bought even a few shares of Google when it went public a little over a year ago, at the now bargain-basement price of $87 (U.S.), raise your hand — the one you’re not slapping yourself silly with, that is.
Plenty of people (including yours truly, if you must know) scoffed at the idea that Google’s stock would take off like a rocket after its IPO. Some analysts at the time were projecting a stock value of $145 a share and a total market capitalization for the company of $25-billion. Dream on, others said (including yours truly).

And where is Google now? Closing in on $350 per share, which would give the company a market value of almost $100-billion — just shy of Coca-Cola and a little behind networking giant Cisco Systems. Shares of Google jumped more than 12 per cent on Friday, after the company announced its quarterly results, results that blew the doors off most estimates.

Of course, one of the complicating factors when it comes to valuing Google is that the search company doesn’t provide a whole lot of information about its business, and doesn’t give forecasts for upcoming quarters, the way most companies do. For the time being at least, that is playing in Google’s favour, allowing it to obliterate even the most positive forecast from Wall Street analysts. Among other things, the search leader seems to be changing a lot of peoples’ minds about the wisdom of a totally advertising-driven business model, and the growth in demand for Internet search-based advertising in particular, and it is growing much faster than the rest of the industry.

Can Google continue this barn-burning growth rate? Perhaps. Clearly, the skepticism that some (including yours truly) felt about such a possibility last year was misplaced.

It’s worth remembering, however, that eBay was also growing at double-digit rates every quarter not that long ago, and now the on-line auctioneer — whose share price has fallen by more than 30 per cent over the past year — is searching for new ways to boost growth to the kind of levels that investors have come to expect. It seems there’s nothing quite so disappointing as a former superstar.

In what is typically not a great quarter for advertising-related companies, Google’s revenue more than doubled to $1.6-billion from the same quarter a year earlier. As with other search engines (such as Yahoo) that get their traffic from a variety of partners, some of that overall revenue figure is made up of “traffic acquisition costs,” which represent the fees that are paid to those search partners, such as America Online, whose search is powered by Google. In the latest period, those costs accounted for about 34 per cent of Google’s revenue, or $530-million.

Even if you exclude those costs, Google’s internally-generated revenue was $885 million, more than twice what the company made a year earlier. In keeping with its previously stated goal to avoid catering to the stock market’s desire for comparative numbers, Google didn’t give the year-earlier figures in its news release — for those, you had to go to the SEC filings from last year. Revenue from Google’s AdSense network, which produces relevant text ads for other websites, rose by 7 per cent over the previous quarter to $630-million, and was higher by about 60 per cent from the same quarter a year earlier.

Several brokerage firms — including RBC Capital and Lehman Brothers — boosted their price targets for the stock to $450. The company’s revenue growth “blows away any reasonable expectations,” said Mark Rohan of RBC Capital Markets. While some people “may view Google’s nearly $100 billion market capitalization as rich, we believe otherwise,” he said in a research note. “Our view is that Google is still a relatively inexpensive stock, and that shares are headed higher.”

To see it as inexpensive at these levels requires some pretty heavy-duty forecasts for future growth, however. Media Metrics Equity Research (which rates the stock a “hold”) said it is concerned that Google’s expenses are rising, margins are falling, and the stock’s multiple is far too high. The firm says the “current risk-reward ratio of owning Google shares is not compelling, in our view” because the stock is assuming that Google’s cash flow will grow at close to 20 per cent a year, compounded annually, for the next 15 years — something no traditional media company has ever done during the past 40 years.

Some analysts, however, say Google is not only the dominant player in search-related advertising, but that its lead is increasing. Susquehanna Research says Google is actually “widening the gap over competitive efforts.” While Overture — which pioneered search-related advertising and was bought by Yahoo — is growing at 7 per cent per quarter, Google grew by 20 per cent. Why? Susquehanna says a combination of market share gains, improved ad quality and pricing, and more revenue from Google-owned sites rather than partners such as Ask Jeeves.

JMP Securities said the company has managed to “significantly outpace the rest of the search industry in terms of revenue per search.” According to JMP, Google generates more than twice as much revenue per search as Yahoo, its closest competitor. The brokerage firm said it sees Google having increasing success in convincing Fortune 500 companies to move advertising spending to the Internet, and based on the company’s projected free cash flow growth over the next several years, JMP says Google should be worth somewhere in the range of $380.

Will Google’s incredible growth begin to slow down at some point? Obviously it will, just as eBay’s has — but not any time soon, as far as anyone can tell. Could all the analysts who are singing its praises be wrong? Obviously they could — but not as wrong as yours truly was about a year ago.”

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