The WSJ describes a key issue facing the big net companies, especially Google: massive (and increasing) capital spending. Last week, for example, Google stated that 2006 CAPEX would “significantly exceed” 2005’s mind-boggling $800 million, prompting analysts to toss out 2006 estimates in the $1.25 to $1.5 billion range. Yahoo! spent $400 million last year, up from $250 million the year before. Amazon’s cranking up spending…
This gives rise to three key questions:
First, what on earth are they (or at least Google) spending that much money on? I understand the need for “servers,” but why has this need exploded so much in the last two years? GDrive? Gmail? Neither of these ideas is revolutionary. Video is a CAPEX hog, but is the difference that vast? Also, why does Google need $400 million more than Yahoo! and eBay do? I shudder to recall this, but CAPEX is where companies occasionally stuff expenses they don’t want to flush through their income statements right away (e.g., Worldcom and Homestore). I have huge respect and confidence for Yahoo!’s financial team, and there is no conceivable reason for Google’s team to play such games. Without having more detail about exactly what the money is being spent on, however, the possibility of shifting capitalization policies can’t be ruled out.
Second, is this simply an up-front investment necessary to build out global capabilities, in which case CAPEX will moderate in future years, or has run a global Internet operation become much more expensive? If the answer is the former, today’s CAPEX is largely irrelevant: The companies can afford it, and a future easing back on spending will drive free cash flow growth rates through the roof. If the spending is permanent, however, these companies (again, Google especially) aren’t going to generate anything like the free cash flow the market is currently expecting.
Third, returning to a point raised in question one, why is Google spending more than twice as much as Yahoo! and more than Yahoo! and eBay combined? Again, explanations about “storage” and “computational power” just don’t ring true. eBay and Yahoo! need storage and computational power, too, and, right now, Yahoo! handles more traffic than Google does. The difference between the CAPEX levels, moreover, is so vast that it seems safe to assume that either Google is overspending (in which case, the question is “on what?”) or Yahoo! and eBay are underspending (in which case, free cash flow is about to take a hit at both of those companies as well).
When Google releases its 10K, we’ll get more insight into where that $800 million went. But this won’t provide any into where this year’s estimated $1.25 billion is going–or how much CAPEX as a percent of revenue will be required to run these companies for the next 10 years.