Monday, November 20, 2006

Google $1000

Google (GOOG) $499

It is easy to see how Google gets to $1,000. The tricky bit is when. We did some projections, with no inflation or time value of money included, and got to the result by posing and answering the following questions:

1. How big is the world advertising market? This should have been the easiest question to answer but, of course, all estimates vary. Our number is $650 billion, a blend of what the largest advertising agencies and investment banks say. Fortunately, this is the least sensitive number in the analysis since we are more interested in market share. Our forecast leaves this number constant, since there is no inflation and we are not assuming advertising itself grows as a sector relative to others;

2. What is the internet share of this market? The blended guess at this point is that internet advertising is around $23 billion or 3.5%. Our assumption is that this could peak at 25%. The argument is a familiar one, but convincing - advertising is a hit-and-miss business which could do with targetting and the internet is excellent and virtually unprecedented in its ability to deliver this (the advertiser knows far more about the specifics of its viewers than they would on TV, radio or even direct mail). Furthermore, it is early days: only one sixth of the planet's population is wired, revenue per viewer/customer is low, the largest advertisers are underrepresented in the buy etc. We find this assumption not too heroic;

3. What about Google's market share? Google is annualizing over $10 billion in revenues right now, to give a share on our numbers of 45%. Most of their business originates in the US. That's an early adopter thing but may also reflect Americanocentric bias in their model. Moreover, while there is a positive network effect in AdSense and Search, there are plenty of uncertainties in how ads will be delivered in the future. We have plumped for a future share of 35%, which would be unprecedented in the media markets. This is the most sensitive assumption;

4. What does this do for Google's revenues and net? The global market in internet advertising, in today's dollars, peaks at $163 billion in this model. Google's share is $57 billion (eight times bigger market, market share off ten points). Their net margin is currently 30% and we let that grow to 40%, allowing for the (considerable) benefit of operating efficiencies but the continuing drag (somewhat considerable) of partner payouts. Google has also been pretty dilutive since the IPO but we are not including the cost of acquistions in this model, taking stock outstanding from 311m to 400m. Earnings per share goes from $10 this year to $57 at peak (we are ignoring the extra couple of dollars earned on the cash pile generated).

5. What is the valuation? If Google reaches this mighty summit - undisputed king of the best advertising medium in history - it will be at maturity valued at some twenty times earnings, we believe, like a mature monopoly newspaper or TV station ten or twenty years ago.

Bingo! Price per share is $1140, easily breasting the catchy Google $1,000 slogan. The question we posed up front was when? The only time driver in this model is the size of the addressable market. Given the conservative nature of ad buys this looks like a seven to ten year migration. So the good news is that if Google remains top the tree and isn't knocked off by a better algorithm, Yahoo (YHOO) or Microsoft (MSFT) getting their groove back, bad execution, the emergence of a new ad paradigm (etc etc) you can expect 8-12% growth in the stock price (over inflation) in the next decade. That's also the bad news.

..................................2006 .....Peak
Ad Market............. 650 ........650........ $billions
Internet share....... 3.5% .....25%
Google share .........45% .......35%
Google revs ...........10.2 .......56.9
Net income .............3.1 ........22.8
Shares out............ ..311 .......400 ........ millions
EPS ..........................9.88 .....56.88 ..... $
Stock price .............499 ......1140
7 year compound
appreciation........................ 12.3%
10 year .................................8.6%

Disclaimer: The authors hold no position in any stock mentioned in this post


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