CASE STUDY 8

Google Press Cuttings

(A) ARE YOU ABOUT TO GET GOOGLED?

Tony Glover

It has been one of the canniest image-building exercises ever. From a standing start less than six years ago, the name Google has risen to stand alongside Coke and Ford as a giant among American brands. The search-engine company, which this weekend is distributing shares to investors who have signed up to its initial public offering (IPO), has become synonymous with being the coolest, fastest, most reliable place to find information on the web.

But all is not well in the land of Google. The IPO process has been bungled: many big institutions who have been left out of the process by the bizarre auction method being used to allocate shares are angry at the way it is being floated. They accuse its founders of wanting too much money and they claim it has an unproven business model.

The behaviour of the two, young nerdish founders in the run-up to the bid has bordered on the farcical. Late last week they were under fire for possibly leaking information – not to a leading financial newspaper or a broker, but to a girlie magazine.

Many fear the IPO harks back to the worst years of dot.com excesses. “You've been googled” looks likely to enter the business world's phrasebook, as a saying for investors being persuaded to buy something risky that they don't really want.

There have been many signs that the IPO has not been going as well as the founders had hoped, although the press releases will undoubtedly claim otherwise. Traffic to the internet site where investors had to register for Google's IPO of stock has been lower than anticipated in the run-up to the Thursday evening deadline for registration to the Dutch auction-style share sale.

Online bookmakers were last week receiving bets suggesting that people expect the share price to drop when trading in the stock begins, supporting the view of most institutions that Google may have set its initial price too high.

Silicon Valley tends to favour positive-sounding buzzwords like “empowerment” over old-fashioned pejorative terms such as “greed”. But, with an initial target price range of $108 (£59.40, E89.04) to $132 a share, Google founders Larry Page and Sergey Brin are valuing their company at a huge 170 times last year's earnings. By valuing their search engine company at between $29bn and $35bn, Google's founders and early investors stand to become overnight billionaires.

The future is less assured for new investors in the stock. Analysts warn that Google's IPO is playing in a very different market today than it was last year, when Page and Brin first announced their IPO plans.

The company now faces heavyweight competition from new rivals including mighty Microsoft. Worse, Google's own business model is being overshadowed by lawsuits and industry reports of companies mischievously manipulating Google's advertising charges.

The behaviour of the founders in the run-up to the bid has also raised eyebrows. An interview with Page and Brin published last week in Playboy magazine cast a cloud over the IPO by potentially breaking US “quiet period”, rules which forbid company executives from releasing price sensitive information in the run-up to a share offering. Earlier meetings with potential investors left many potential investors frustrated at the lack of key financial information.

In addition, the world that Google will be trading in is likely to change dramatically over the next few years. Although the search engine company is a different proposition to the failed dot.coms of five years ago, generating revenues of $1.5bn last year, roughly 95% is from online advertising, and the company's business is still far from mature. Search engines are still in their infancy and the internet itself is about to undergo a revolution that may make many of today's business models redundant within a year. Microsoft and Yahoo are developing software designed to surpass Google's current search engine.

Microsoft is also a key player in the video and audio revolution that is about to transform the internet from a text and picture-based medium to a kind of interactive TV and film library. This transformation is being made possible by the global rollout of broadband internet connections. Data speeds fast enough to receive live video streaming are fast becoming standard in fixed-line internet connections with wireless connections using technologies such as wi-fi and wi-max catching up.

Google could rightly argue that the expansion of the internet represents a vast revenue opportunity. The theory is that by buying into Google at the dawn of the internet's new age, investors are getting into the next Microsoft on the ground floor. But the trouble is, Microsoft itself, with tens of billions in ready cash, has its own plans to become the next giant of the broadband internet age. It has already signed software deals with service providers such as British Telecom as well as with the world's leading electronics manufacturers. Rival Yahoo also has an advantage over Google because of its large, loyal customer base of e-mail users.

As a small start-up and as a private company, Google was able to run through the legs of global corporations like Microsoft and establish a reputation for irreverence and humour. Its propensity to add seasonal features such as snow to the tops of the brightly coloured lettering of its distinctive logo bears testimony to its founders' youthful exuberance, as do the extensive recreational facilities of its sprawing Googleplex offices.

But as a listed company with a market value of around $30bn, Google will be thrust into the adult corporate world of quarterly reporting and share-price fluctuations. Its founders argue that, by selling direct to small investors, the company will retain an independence not shared by blue-chip rivals who must take the views of their big institutional investors into account …

Because of the unique way in which Page and Brin have decided to bring their company to market, these challenges could have a disproportionate effect on Google's share price. Google is more vulnerable to shifting market sentiment than it might have been had it pursued a more traditional strategy. Most major IPOs are done in close collaboration with major stockbrokers who place the bulk of the shares with a small number of financial institutions. This enables the brokers to set the share price accurately in advance of the offering. Page and Brin eschewed this method because they wanted to retain independent control of corporate strategy after the IPO and because they believed they could raise more cash by auctioning Google shares over the internet.

Some of the annoyance at the process of the IPO is undoubtedly down to sour grapes and lost fees. Wall Street has largely been excluded from Google's IPO process and, at a time when investment banking revenues are low, the bankers fear they are missing out on the hottest deal of the year.

Yet it is hard to dismiss claims that the hyping of the share offering is obscuring real worries about the IPO, in the wake of market uncertainty and the series of corporate blunders. Google has been one of the darlings of the recent dot.com revival.

Those who invest in Google must hope that they haven't “been googled” and set to become victims of the hubris and overblown expectations that have characterised many companies in the technology sector over the past few years.

(B) IGNORE WALL ST'S WHINING – GOOGLE'S IPO WORKED

James Surowiecki

When Google went public yesterday, it immediately became one of the most highly valued companies in the world. Sergey Brin and Larry Page, its cofounders, are now billionaires (at least on paper). And the company raised an immense pile of cash that will stand it in very good stead as it faces an increasingly competitive future. You might think, then, that Google's initial public offering was a success. But that is far from the message from Wall Street and much of the financial press. They prefer words such as “debacle” and “amateur hour” to describe Google's performance. On this view, Google looks like a runner staggering across the finish line, out of breath and gasping for water.

The obvious reason for describing Google this way is that the company had to cut the price of its share offer and reduce the number of shares that would be sold. Wall Street has interpreted this as evidence that Google's decision to circumvent the traditional IPO process – going directly to investors with a “Dutch auction” instead of allowing an investment bank to underwrite its shares – was a terrible mistake. Had the company just given itself over to the Street's warm embrace, everything would have turned out fine.

This is undoubtedly a comforting story for investment bankers to tell themselves as they cling to their lucrative sinecures. But that is bunk. In the first place, Google's valuation is, by any standard, a quite healthy one. When the company first announced it was planning to go public, most estimated that the company would end up with a market cap of $15bn (£8.2bn) to $25bn. When trading started yesterday, it was worth $27bn. The company did have to mark down its price from the initial range it had suggested back in April, but that was almost entirely the result of the recent minor meltdown in technology shares.

If Google's unorthodox method of going public has had any impact on the company's stock price, it is only because it forced Wall Street into a concerted whispering campaign designed to sabotage the IPO. It is hardly a coincidence that after Google directly challenged Wall Street's stranglehold on the capital-raising process, it suddenly went from being among the mostloved companies in America to among the most criticised. Much of the badmouthing we heard before the IPO came from money managers looking to talk down the company's price so that they could get a better bargain. One of the more laughable aspects of the whole Google circus has been false sanctimony about “valuation” from money managers who happily bought Cisco when its market capitalisation was $400bn and from Wall Street investment banks that bid internet stocks up to billion-dollar market caps. We can be forgiven for thinking that something other than devotion to the principles of Warren Buffett is at work.

As self-serving as most of these attacks on Google have been, even more dismaying have been the criticisms levied against the Dutch-auction method. Because a Dutch auction in effect allows investors to set the IPO price collectively it makes it unlikely that a company's stock price will soar soon after it goes public. This is an entirely good thing, since the higher the price at which a company goes public, the more money it will raise. But in the looking-glass world in which Google has found itself, the absence of that big first-day “pop” has been labelled a problem, proof that the company is “greedy” and that the whole IPO has been just a greed-fest.

This is a sign of how much of our thinking about markets is deeply confused. The stock market is, at least in part, a mechanism for allocating capital (and during an IPO, that is exactly what it is). The better it does that job, the better the economy as a whole will be. What that entails is getting prices roughly right. A big first-day pop is a sign that the opening price was wrong, not a sign that it was right. As for Google's supposed greediness, it is doing precisely what it is supposed to be doing: maximising the value it gets for selling off part of the company. Because it used the Dutch auction, it knows it is getting what people were really willing to pay, instead of what a coterie of investment bankers thought their friends and cronies should have to pay.

Google's IPO was hardly perfect. But it looks positively brilliant compared with the way Wall Street takes companies public. That route is rife with conflicts of interest and gives investment banks a clear incentive to hold down the opening price – essentially taking money from a company and distributing it to the investment bank's clients and customers.

Wall Street can spin this however it wants. But Google went public without underwriting from a major investment bank, without handing out favours to well-connected executives and without dictating a price in the manner of Soviet central planners. Because it did, it now has hundreds of millions of dollars that it would not otherwise have had. By any standard, this was one IPO that worked.

(C) GOOGLE'S EARNINGS MORE THAN DOUBLE 1ST QUARTERLY RESULTS AS PUBLIC FIRM STRONG

Robert Weisman

Web search provider Google Inc., posting its first financial results as a public company, yesterday said its third-quarter earnings and revenues both more than doubled from a year ago on the strength of an online advertising boom that continues to gather steam.

Google's shares jumped $8.89, or 6.33 percent, to $149.38 in Nasdaq trading yesterday in anticipation of the earnings report, which was released after the market closed. In after-hours trading, Google's shares continued racing ahead, reaching a high of $162.15. The company, based in Mountain View, Calif., priced its stock at $85 a share on Aug. 19, raising $1.67 billion in an auction-style initial public offering that had riveted the attention of the investment community throughout the summer.

Because company executives have broken with technology industry practice by refusing to offer guidance about their financial outlook, investors had looked to yesterday's report to help them gauge the value of a stock that has behaved like a dot-com era highflier over the past two months while the overall market has been weak.

The results did not disappoint. Google's earnings of $52 million, or 19 cents a share, were up from $20.4 million, or 8 cents a share, in the July-to-September period last year. And without one-time charges to cover its stock-based compensation and the settlement of a patent dispute with rival Yahoo Inc., Google said it would have earned 70 cents a share. That beat the consensus estimate of 56 cents a share from securities analysts polled by the Thomson Financial research firm.

Google executives, in a conference call with analysts, said the company is continuing to ride the wave of Internet advertising, which it distributes next to its search results and next to content on third-party partner sites. “Online advertising is becoming a larger and larger percentage of global advertising spending,” noted Larry Page, Google cofounder and president for products. Google's own sites accounted for 51 percent of its advertising revenue for the three months ending Sept. 30, with its partner sites accounting for 48 percent.

The company reported overall third-quarter revenue of $805.9 million, up from $393.9 million for the same period a year ago.

While the company's top managers discussed a range of new initiatives, from the launch of a desktop search feature to the opening of a European headquarters in Dublin, they stopped short of unveiling the kind of integrated strategy some Google watchers were anticipating.

“Until such time as they know what the whole house is going to look like, they're not going to reveal the blueprint,” suggested David M. Garrity, a technology analyst for Caris & Co. in New York, who said Google's valuation may be justified not simply by Internet advertising but by a larger computing strategy. “Right now they're still in the process of expanding into their potential end point, which is replacing Microsoft. I think their intention is to take our computing experience and make it more Web-centric rather than personal computer-centric.”

Google faces stiff competition from Microsoft and Yahoo, which have beefed up their search initiatives this year.

While noting the strength of Google's business, Scott Kessler, a Standard & Poor's equity analyst, said he was concerned about the run-up of its share price. “A lot of people see that these shares are being bought regardless of valuation,” he said. “But once there's a chink in the armor, people will sell the shares without reservation.”

(D) HOW HIGH CAN GOOGLE FLY?

Verne Kopytoff

The popular Internet search engine has defied gravity since the company's high-profile initial public offering less than six months ago.

Google's stock has soared 140 percent, closing Wednesday at $205.96, up $14.06 on the heels of a stellar fourth quarter. The rise has been so dramatic that the company, once run out of a Stanford University dorm room, now has a market capitalization of $56.3 billion, larger than eBay and Yahoo individually and larger than General Motors and Ford Motor Co. combined.

Several analysts are predicting even bigger success for Google's stock over the next year. However, the forecasts raise comparisons to the Internet bubble, when some analysts made stratospheric projections about companies that ultimately foundered.

Whatever the case, Google has consistently defied naysayers. The legions of investors who stood on the sidelines for the company's IPO, believing the stock at $85 was an impending train wreck, have missed out on a big potential payday.

“The company has certainly been able to drive revenues at a better rate than we thought possible,” said David Garrity, an analyst for Caris & Co. who increased his price target on Google Wednesday to $300.

Other analysts issued reports Wednesday that were almost as positive. John Tinker of Think Equity Partners placed a target of $290 on Google's shares in a report titled “Search On.” Mark Mahaney of American Technology Research upped his target to $275 in a note titled “The Michael Jordan of the Nets.”

Garrity denied any return to the overexuberance of the late 1990s, saying: “Back then, these were companies that were hemorrhaging cash, these were people who were blowing half their annual ad budgets on a 30-second Super Bowl ad, and holding parties that cost way too much.”

Indeed, Google is unlike its predecessors. For the fourth quarter, the company reported a profit of $204.1 million on $1.03 billion in revenue.

Google, based in Mountain View, makes its money by running ads alongside its search results and on partner Web sites. Each time a visitor clicks on an ad, the advertiser pays a fee.

Using Wall Street's favorite stock yardstick, the price-to-earnings ratio, Google's shares are pricey. Based on Wednesday's closing price, Google's price-to-earnings ratio for 2004 was 142.8 versus 26.2 for the Nasdaq 100, 69.2 for eBay and 61.7 for Yahoo.

But analysts expect Google's valuation to become more reasonable in the future because of its rapid growth. For 2005, analysts forecast the company's price-to-earnings ratio will be 53.34 versus 51.44 for eBay and 67.95 for Yahoo.

However, Pete Sealey, an adjunct professor of marketing at UC Berkeley, is skeptical of Google's ability to sustain the climb. He said that the frenzy hasn't reached the proportions of 1999, but that hype is nevertheless a factor in the rise.

“If I were advising someone in my family or investing money for my kid's college education, would I put my money in Google?” Sealey said. “No.”

There's too much risk, he added. Yahoo and Microsoft's MSN could ultimately steal market share and hurt Google's financial prospects, he said.

Don MacAskill, who bought five Google shares in its initial public offering, said that he is happy with the stock's performance and has no plans to sell. He bought in for the long term because of the way the company is run and its unconventional policies such as refusing to give financial forecasts in defiance of Wall Street tradition.

MacAskill, who is chief executive of Smugmug, an online photo storage service in Mountain View, said that many investors in eBay's IPO sold their shares quickly, missing out on that company's subsequent meteoric ascension.

“For me, the decision to sell would be more based on the behavior of the company in terms of its approach in hiring and taking care of its employees than actual financial numbers,” MacAskill said.

(E) BOWLING FOR GOOGLE

Paul R. La Monica

Is Google on its way to hitting a perfect bowling score, a $300 stock price, in the near future? At Tuesday's closing price of $256, it's less than 20 percent away.

Shares of the leading search engine have been on a tear, shooting up 25 percent since the company reported much better than expected sales and earnings for the first quarter, thanks to a booming market for online advertising.

During the past month, Google has also released several new features – including a desktop search function for businesses and a test version of a personalized home page tool – that should help the company remain competitive against rivals Yahoo! and Microsoft.

Most recently, speculatoin that Google will soon be added to the S&P 500 index has helped propel the stock higher.

So is it possible that Google could continue climbing? Is $300 in the bag and should we be talking about Google hitting $350 or higher?

Investors Still Feel Lucky

Crazy as it may sound, Google could still have a lot more upside. Sure, the stock price looks frothy on an absolute basis. Few companies have prices in the triple digits, let alone, approaching $300.

But Google has maintained that it would not split its stock to make the shares more affordable for the average investor. Clearly, that hasn't hindered the stock's performance.

In fact, data from Vickers Stock Research suggests that Google's surge has been fueled by retail investors, not big mutual funds. According to Vickers, only 35 percent of Google's shares are held by institutional investors while 73 percent of Yahoo!’s shares are owned by mutual funds and other money managers.

So what's more important for investors to look at is not the dollar amount of Google's stock price but what Google's valuation is relative to its peers. And on that basis, Google still looks reasonably attractive, if not exactly cheap.

Shares trade at 50 times 2005 earnings estimates and 39 times 2006 projections. Yahoo!, on the other hand, trades at 64 times 2005 profit forecasts and has a P/E of 50 times 2006 estimates.

Steve Weinstein, an analyst with Pacific Crest Securities, said that Google's fundamentals could justify a $330 stock price. At that level, Google would trade at a multiple in line with Yahoo!

If anything, Google looks to be the company that deserves the premium right now. It has reported stronger gains in sales and earnings than Yahoo! lately since Google has more exposure to the online advertising market, specifically ads tied to key word search results, than Yahoo!

“In the short-term, Google could grow faster than Yahoo!, as it has over the past few quarters,” said Marianne Wolk, an analyst with Susquehanna Financial Group.

To that end, earnings estimates for Google have risen at a meteoric pace.

Three months ago, analysts expected Google's earnings to come in at $3.94 a share this year. Now the consensus estimate is $5.14 a share, an increase of 30 percent. Likewise, estimates for 2006 have surged nearly 30 percent in the past three months, from $5.14 a share to current projections of $6.56 a share.

By way of comparison, estimates for Yahoo! have increased by about 10 percent for 2005 and 2006 during the past three months.

Searching for the S&P 500

The S&P 500 speculation is also worth keeping an eye on. I wrote last year about why I thought Google probably would be added to the index sometime in 2005.

At the time, the only major knock against Google was that less than half of its outstanding shares were available to the public. One of Standard & Poor's criteria for adding a stock to the index is that a company's float, or available share, must be at least 50 percent of the total shares.

That's no longer an issue. According to Vickers, the float now accounts for nearly two-thirds of shares outstanding. And if Google does get added to the S&P, many institutions that run index funds would have to buy the stock.

“We view the possible inclusion of Google in the S&P as a potential positive catalyst due to the relatively low institutional ownership as compared to Yahoo! and eBay,” wrote David Edwards, an analyst with American Technology Research in a recent report.

Since going public last August, Google has faced a lot of skepticism (from me included) and has defied all the critics.

Fears about how the stock could take a hit following a deluge of new shares hitting the market after IPO lock-up periods expired were for naught.

Worries about a slowdown in Internet ad spending proved temporary.

And the valuation, while rich, never seems to have gotten ahead of itself because the stock has simply moved higher as earnings estimates for Google have increased.

So as long as online ad spending doesn't take a sudden sharp turn downward, it's hard to imagine Google's stock losing serious ground.

“Internet advertising is in its infancy. The long-term prospects for Google are quite strong,” said Wolk.

(F) GOOGLE'S RISING SHARE PRICE IS COLD COMFORT FOR INVESTORS

Stephen Schurr

Google's stock briefly reached $300 last week, a stratospheric rise from its $85 offer price less than a year ago. The good news for Google investors is that the stock's valuation has not approached the insane, untenable levels touched five years ago by the likes of Cisco, Oracle, Yahoo and JDS Uniphase.

The bad news: Google's valuations can be justified only in the best of all possible worlds, and even then, returns may be decidedly less than investors expect.

Before 2000, no stock market had seen companies with market capitalisations in tens of billions carrying price-to-earnings multiples near 100. It is also worth noting that none of the above companies trade anywhere near their bubble-level prices. On current estimates, Google, whose market cap is $82bn, sports a price-to-earnings multiple of 56.

“While we're not where we were five years ago, Google is still extremely high,” said Jeremy Siegel, finance professor at Wharton and author of The Future for Investors.

The online search engine is expected to increase its earnings by 33 per cent a year for the next three to five years – no small feat, even for a growth company of epic proportions such as Google. If it achieves that growth, and the stock hits returns of 10 per cent a year for those five years, Google's p/e will be a high but reasonable 22 after five years.

In this sanguine scenario, Google continues its rapid growth, stockholders get 10 per cent a year and the stock is reasonably valued.

But are Google's risk-friendly investors comfortable with accepting huge potential downside risk for 10 per cent a year?

The fact that Google compares favourably with 2000’s burst bubble is cold comfort. “Right now,” said Fred Hickey, writer for the High-Tech Strategist newsletter, “Google is the mania.” He notes that most of Google's earnings rise stems not from internet growth, which is slowing, but from price rises for the word-search-based advertisements it sells.

Of all the lessons of the tech bubble, two best apply to Google. First, in technology, no moat can protect you from competition. Second, earnings growth based on pricing power almost inevitably erodes due to competition. Arguably the only company that has been able to defy these lessons is Microsoft, which also presents a threat to Google.

The risk associated with Google's stock may have been best summed up by Steve Ballmer, Microsoft chief executive. In an interview with Computer Reseller News, Mr Ballmer was asked why he did not just buy Google.

He said: “There's not something there I want to buy. I'm not saying it's not a good company. It's a very expensive company. Do you actually believe there's not enough innovation in search that somebody's not going to challenge them? It's the easiest application in the world to switch.”