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Google 49, Yahoo 0

First things first: A hat tip to Google and its champions.  It’s hard to express how impressive the company is, both in the numbers it is posting and the amount of confidence and ambition it has.  Given the awesome rate of growth in the last eight years, lesser companies, or lesser people, would have blown apart at the seams.

Second: It is also hard to express how pathetic Yahoo seems in comparison.  Only a year ago, the company was firing on all cylinders, gaining market share, innovating, inspiring the same kind of confidence that Google now does.  Now, it’s hard to imagine what the company will be able to do to stop the market share bleed.

Third: Despite the strength of the quarter, I stand by the prediction that, if the online ad market weakens, Google will feel it.  Given that YouTube and Sequoia agreed to an all-stock transaction, it seemed unlikely that we would see weakness in Q3, but Q4 could be a different story.  And I continue to think that the signs from Yahoo and others are that the market has started to weaken.

Fourth: I’m glad I own the stock in an index fund, but I’m also still glad I don’t own any more than that.  Thanks to continued strength over the past year, the company is growing into its valuation, but it’s not there yet–especially in the face of a potential market slowdown.

At $450, ex cash, Google’s market-cap is about $125 billion.  The free cash flow run-rate is about $2 billion, the same as it has been for the last year.  If we assume that the company is over-investing in CAPEX and that it will soon throttle back, the “normalized” free cash flow run rate might be $3 billion.  So the stock is trading at about 40X normalized free cash flow.

Is that a fair multiple?  It could be–if revenue growth settles into a steady long-term growth rate of 40%-50% and margins stay the same.  If revenue continues to decelerate, however, or the company stumbles, the multiple could easily compress to 30x, especially given the sheer size of cash flow.  So, as excited as I am about the company, it’s still hard to get that excited about the stock at $400-$450 a share.

But I am glad I own it in an index fund…

17 thoughts on “Google 49, Yahoo 0”

  1. Henry I was the first to call 1.86, don’t let that other clown take my glory. Let me tell you though, i think q3 will be nothing compared to q4.

    But mark my words, we’ll be here again, same time next quarter with people worrying about Google missing earnings estimates.

    Something fundamentally secular is going on in internet advertising and I wish people would stop using Yahoo as a yardstick for the secular trend. Yahoo is a failure. It’s a flop. It’s a has-been. This company is definitely a $500 stock.

  2. Henry,
    Not sure why you are so negative about Google. Since you flipped your Google shares a few minutes after you “won” it through the auction, you have been consistent wrong on Google. I don’t know what could turn you positive on this stock? Tell us!

  3. Google’s revenue growth over the past two quarters has been almost entirely because of one advertiser- dadamobile.com

    This is a company based in italy that buys hundreds of millions of dollars worth of internet advertising from Google, for “Free XYZ ringtones!” or “Complimentary XYZ ringtones!”

    You go to one of those sites, under a thousand different domain names but all owned by dadamobile, enter your cellphone number for your “free” ringtone, then find yourself subscribed to a 20 dollar per month ringtone “plan” that you cannot unsubscribe from.

    Read any of the SEO or webmasterworld forums and you’ll find that most people in the online text ad business are devoting a majority of their time developing dadamobile ringtone campaigns. The stuff pays more than “mesothelioma” per click.

    Dadamobile is being sued by the FTC is all 50 states in this country, but as its headquarters are in italy they manage to keep operating with hundreds of shell corporations.

    Yahoo and Microsoft have over the past few months stopped doing business with dadamobile, but Google continues to power ahead with them. In fact, over the last two quarters, it is widely believed by those in the SEO crowd that dadamobile has become google’s largest advertiser- pushing ebay out of that top spot.

    The question is- how much longer can Google depend on cell phone fraud to power its earnings growth?

  4. <>

    With respect, that is meaningless. Any company will feel the effects of softening in its key market ..IF AND WHEN that ever happens. No stock goes up in a straight line and as Google doesn’t guide, there will be a quarter when the stock will take a hit. That’s 100% certain so pointing that out isn’t rocket science and hardly counts as perceptive analysis.

    Apart from yahoo, you offer no evidence of a market slowdown. You are also logically inconsistent. If yahoo’s soft numbers are evidence to you of a market slowdown, why don’t you use Google’s earnings as evidence of a strong and growing online advertising market ? You are being selective.

    The fact is no one knows the future. if bad things happen Google will also feel them – like any other company.

    That said, I agree with the Citigroup analyst who expects Q4 to be even stronger ( due to strong retail trends going into the holiday period).

  5. There’s still LOTS of room for further revenue growth in online advertising, Google or not.

    Example : Next week, I should be meeting with a new entrant to the financial services market. They will want to be advertising heavily in the UK market, using the major PPC platforms.

    Once we’ve had a couple of months to get their campaigns organised, they’ll be spending £100k – £250k per month in PPC, probably averaging around £2.5m / year.

    That sort of thing happens EVERY DAY to online advertising platforms, new multi million £ / $ accounts just appear. A lot of this money (and the other “new money” coming into PPC) is from VC’s. Startups, online or not, know that the WWW is their best chance of getting exposure quickly, measurably and efficiently. So long as people start companies, the revenues will grow fast.

    The growth in Googles PPC base will flatten eventually, as the market approaches saturation, and “new” PPC spend goes into platforms with better ROI (YSM and MSN mostly – smaller PPC engines just don’t have the capacity to absorb a great deal of spend).

    I just don’t see that flattening happneing for a couple of years yet – there are still considerable inefficiences in the AdWords market, which could “fund” several quarters of continued growth

  6. Why are people so impressed with 10% sequential growth? That’s not really hypergrowth. Do that 4 times and it’s less than 50% year-over-year.

  7. There is a significant chance for a big miss with google’s earnings this quarter. Why? IE7 is now shipping, and being automatically updated to hundreds of millions of users.

    And IE7 has a search toolbar built in- that uses microsoft’s Live search engine.

    Making Live search the default for hundreds of millions of people could take a MASSIVE chunk of google (and yahoo’s) traffic away.

  8. none,
    Not going to happen. People do not use google because it is on their browser toolbar. They put it on their toolbar because they like using google search. Subtle difference.
    Google has created an ecosystem now which creates stickiness. People won’t leave it for a ‘me-too’ product which is what live search is – even if it is just as good.

  9. Did you just use the word “ecosystem” and “stickiness” in the same sentence?

    Why don’t you just go all the way and use “synergy” too?

    BTW- Ever hear of a company called AltaVista? They used to completely own the search engine world. Until other people came along.

    And you are utterly wrong- there are hundreds of millions of computers out there that DO NOT HAVE ANY SEARCH TOOLBAR AT ALL INSTALLED.

    Now all of those are going to get the MSN toolbar, whether they like it or not. It’s built into IE7.

    But hey- I’m sure nobody will ever use the default included stuff in windows- that’s probably why Google execs were begging Congress three months ago to stop Microsoft from putting the search toolbar in the browser. They were just doing that begging because they like to hear their own voices, not because they themselves saw the IE7 toolbar as a threat.

    Get real.

  10. Jim – saying that Google’s revenue growth over the last two quarters has primarily been driven by one ringtone advertiser in Italy *has* to be the most ignorant & hyperbolic investment-related statement on Google that I’ve ever heard.

    Thanks for making my Friday,

    Chris

  11. Chris, do you even know what dadamobile is?

    Do you have any idea how much they pay for keywords?

    Do you have any idea the frequency with which their ads now appear on Google’s affiliate network? (adsense)

    Here’s a hint- their ads appear from 5-9% more often than ebay ads. Ebay USED to be the largest single buyer of ads with google- but not anymore.

  12. Henry,

    You have never had any idea what you were talking about from oppenheimer to merrill to this blog. Your first snafu was the Google to $100, now you cry wolf at every turn and, eventually, will be right but TheGoog may be at $250 billion by then and actually be worth it unlike those things u pitched in the 90s. Your next snafu is in assuming that as you say now 3Q had to be good because youtube and sequoia took stock – the fact is the deal hasn’t even closed so the fact the stock is going up means the 30-day trailing exchange price will allow Google to give up less of the company in shares than it would have done if the stock were going down. If youtube and sequoia should have wanted anyting it was a weakish 3Q. Maybe you should stick w your consulting gig or whatever it is you are doing now. Regards.

  13. Yes, I agree that Sequoia and YouTube have confidence in the company–that was my point. If they hadn’t, I doubt they’d have taken all stock, regardless of the tax consequences. (I’m not suggesting they would have taken all cash, just some cash, to take something off the table.)

    And given that Michael Moritz, et al, surely know that companies rarely have just one weak quarter, that an “8% sequential print” would likely have signaled a major deceleration (and a stock headed to $250 in a quarter or two), I doubt YouTube and Sequoia would have preferred that outcome. The advantage to Sequoia being on both sides of the deal, moreover, is no one had to “hope” for anything–because they already knew.

    I’ve never suggested the Google’s stock price was ludicrous, just expensive. Given the potential downside if they stumble, I’d still characterize it that way.

    The company’s performance has been nothing short of amazing, and, as a result, over the past year, it has grown into what was once a very expensive valuation. (Which it would not have done had the stock not stayed in a trading range). If the performance continues, the stock will surely go higher. If it doesn’t, the stock will tank. I’m sure we all can agree on that.

    So…care to make a prediction?

  14. You bet I do. YHOO is this decades AOL (another winner you pitched in the ’90s). GOOG’s earnings power and market positioned is still underestimated and GOOG will be the best performing LC internet company (fundamentals and share price) for the next 1,3,5,7, and 10 year period. Oh, and one other thing, its peak multiple will not be realized until no-nothing, nay-sayers like yourself all fold their cards. Its undervalued at 25x 2008 and is probably worth between 30x-35x forward earnings. Not excessive for 4x industry growth and 80% organic growth at a $10 billion run rate. The only question is, when will GOOGs earnings exceed YHOO revenue, care to make a prediction?

  15. suzq,
    What you unwittingly demonstrate is that click fraud represents a cost to both the advertiser and Google.
    Click fraud is a cost that is already (or quickly will be) factored in to advertising rates.
    Advertisers only advertise
    when benefit/cost is positive.
    The more click fraud the cheaper the ad rates – otherwise advertisers would walk away.

  16. Are you SERIOUSLY quoting the Washington Post as an authority on click fraud? Hilarious!

    >> my other bet is a federal investigation will reveal algorhythms set up on computers, probably somehwere in India, that do nothing but click, click, click all day on banners

    BWAAAAAhahahahaha! That’s so ignorant it’s funny! How are the Feds going to investigate anything in India? I have the funny feeling that even the mighty FBI will have trouble extending their jurisdiction to another continent, especially when NO CRIME HAS BEEN COMMITTED. That’s right, “click fraud” is not a crime. I could sit here clicking “personal injury lawyer new york” ads all day, and never fear a policeman.

    And, banners? Please, that’s soooo 2001. Do you even know what the Adwords program is?

    Click fraud is only a little different (conceptually) to good old circulation inflation – and I don’t see many class action lawsuits going on there. It’s only the fact that online advertising is so much more accountable and trackable that this conversation is even taking place : advertisers have been ripped off for decades by traditional media, and the trads don’t like being shown up.

    Of course click fraud exists. I know a couple of Eastern European guys who’ll throw a bot at anyone you like (or don’t like, I guess) for a few hundred pounds. Don’t expect to bankrupt your competitors directly that way though, because the SE’s are quite good at spotting and blocking / refunding that kind of obvious activity.

    Walt about sums it up : click fraud, such as it is, is already factored into PPC bid prices. If you can’t get sufficient quality traffic at a given price, you drop your bid. Eventually, if your bid was continually dropping due to fraud, you’d simply drop out of the market. If click fraud was as endemic as some people seem to think, no merchant would ever make any money from PPC, the model would die, and THAT woul dsolve the problem for all time.

    Strangely, a lot of people seem to do OK from buying PPC traffic, so much so that they can afford to throw billions of $$$ at Google (and their competitors) every year, and at an increasing rate. The evidence suggests click fraud just doesn’t amount to much

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