There may be doubts about many things as far as search giant Google Inc. is concerned – how many billions its initial public offering will raise, how far the stock will soar on the first day of trading, whether the company will be able to withstand competition from Yahoo and Microsoft, and so on. But there is little doubt about two things: number one, Google is great, and number two, Google's IPO has created a frenzy unlike almost anything since man landed on the moon. Amid all the hubbub, investors will have to keep their wits about them and consider the only important question: How much is this great Internet business worth?
One of the biggest problems when it comes to valuing Google as a company is the fact that other public Internet giants are trading at such astronomical levels, and the market's immediate tendency will be – has already been – to draw a line from Google to them and assign a similar multiple to the search company. That's how analysts arrive at numbers such as $25-billion (U.S.) for Google's market value once the issue is done and the stock starts trading. But does that kind of value make sense, even for the greatest Internet company since eBay?
According to Google's filing with the U.S. Securities and Exchange Commission on Thursday, the company had sales last year of close to $1-billion and net income of $105-million. That isn't really all that large, but the kind of growth the search firm has seen in its relatively short life is staggering by almost any measure. In 2000, its revenue was just $19-million; the next year it more than quadrupled to $86-million; in 2002 it quadrupled again to more than $347-million; last year it almost tripled to $962-million. Needless to say, that kind of growth rate is a large part of what has investors drooling over the company's IPO.
There's no question that increasing your annual revenue by a factor of 50 in just four years is a tremendous feat, and one that is worthy of admiration. But with all due respect to Google founders Sergey Brin and Larry Page – soon-to-be billionaires who are still in their 30s – that isn't what investors are going to be buying if they invest in Google. They're going to be buying the promise of future growth, and that is still a very large question mark.
Yahoo, which is no piker in the Internet space itself, is stepping up its competition with Google after years of being a major partner, and Microsoft is also beefing up its search abilities. Google, which rose to prominence as a result of its fast and accurate “page rank” technology, already accounts for the majority of Internet searches, and is a major player in the paid-search market along with Yahoo (which bought paid-search pioneer Overture last year). How much growth is there left? Could the company triple or quadruple its revenue again, or is that kind of growth in the past now?
Then there's an even more important question, and that is how fast Google's profit is likely to grow, since that is what investors are supposed to be paying for – although you wouldn't know it from looking at some stocks such as Yahoo and Amazon. Google has made money for the past three years straight, and the $105-million it made last year was more than 15 times the profit it made in 2001. However, the company's profit only rose by 6 per cent last year compared with 2002, and on a per-share basis it actually fell by 8 per cent because there were more shares outstanding. In its securities filing, Google said that it expects its operating profit margin to fall this year.
So the big question remains: how much should all that be worth? Analysts have arrived at number such as $25-billion by applying the same kinds of multiples that Yahoo and other Internet giants trade at. Yahoo, for example – which also started as a search engine, only to have its spotlight stolen by Altavista and then Google – is currently trading at more than 17 times revenue over the past 12 months, with a market value of $36-billion. Auction site eBay, meanwhile, is trading at 22 times its revenue with a market cap of $53-billion.
To some, that means Google should be worth between $20-billion and $25-billion, using a 20 to 25 times multiple. It is seen by many as a more valuable business than Yahoo's, even though they both rely primarily on Internet advertising (Google said ad revenue accounted for more than 90 per cent of its sales in 2003). Is it a better business than eBay's? Not if you look at net profit margins it isn't: eBay's profit last year worked out to more than 20 per cent of sales, while Google's worked out to about 10 per cent of its revenue. On that basis, it's a lot closer to Yahoo's margins, which worked out to about 11 per cent of revenue.
Those considerations aside, however, investors still have to ask whether any business is worth 20 to 25 times its revenue – whether that business is Yahoo or eBay or Google. At least eBay regularly increases its sales and profit by 60 or 70 or even 100 times quarter after quarter. Google has done that in terms of sales, but its profit growth has been somewhat less stellar of late, its margins are falling and competition is continuing to heat up. That's not to say Google won't continue to grow, but at rates that are worth 20 times sales? That assumes an awful lot of growth.
It's also worth remembering another key element of the issue – apart from the fact that it will be a Dutch auction (in which the company issues shares at the lowest price necessary to raise the amount it wants to raise, which in this case is $2.7-billion). And that is the fact that the founders will retain control over the company through the use of multiple-voting shares, which give each of their shares 10 votes. In other words, even paying 20 times sales or whatever the stock winds up trading at won't get you an equal vote in what happens.
Just a few things to consider as the Google frenzy continues to build.
© The Globe and Mail
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