BUSINESS

A STEAL AT $700 A SHARE?

Google has defied the doubters before. How high can it soar?

COLIN CAMPBELL January 14 2008
BUSINESS

A STEAL AT $700 A SHARE?

Google has defied the doubters before. How high can it soar?

COLIN CAMPBELL January 14 2008

A STEAL AT $700 A SHARE?

Google has defied the doubters before. How high can it soar?

BUSINESS

COLIN CAMPBELL

Necker Island, in

the British Virgin Islands, is a blip in the Caribbean—a remote spot surrounded by white sand beaches and crystal clear waters. Hardly the kind of place you’d expect to find the event that had the high-tech world buzzing last month. But this was where Google co-founder Larry Page chose to be married. And anything involving Google is big news in Silicon Valley. Like any good celebrity event, there was plenty to gossip about. According to websites following the wedding, the island’s owner, business mogul Richard Branson, stood in as the best man. The website Valley wag.com gleefully tracked a late-season tropical storm making a beeline for Necker. Would it ground the private jets and helicopters delivering the billionaires said to be on the guest list, or throw a wrench into a party that had been in the works for six months? At the last moment, the storm miraculously veered off. Pictures on the Internet showed that things went off without a hitch.

No surprise there. These days, nothing bad seems to happen to the folks who dreamt up Google. The ambitious duo, Page and his business partner Sergey Brin, created a company that in less than a decade has gone from a couple of guys working out of a rented house to an Internet empire with one of the world’s most recognizable brands. Google has defied critics for so long that a bet against anything Page and Brin do now seems like a bad one.

When Google went public in August 2004, people thought its shares were overpriced at $85. Its model of organizing information on the Internet and tying it to ads was profitable, but surely not that profitable. When the stock price crossed $200 in 2005, people again said it was too high. Likewise when it hovered around $400 in 2006. Critics said Google was

a bubble just waiting to burst. By the time it hit $700 for the first time on Halloween in 2007 (and again in December), most Google watchers had established a pretty good track record of being wrong. A select few still say $700 is a bit too rich—a report from Standard and Poor’s last month set a 12-month target price of $670. But most analysts, thrice-bitten, are no longer talking about Google being overvalued. Instead,'they’re looking at how much higher its shares might go, especially as the company sets off on its bold plan to expand into the wireless world and take on its older, bigger rival, Microsoft, by offering its own Web-based office software. Is it possible that even at $700 a share, with a market value greater than that of General Motors, Boeing and McDonald’s combined, this company could actually be undervalued?

Google is so recognizable it’s like the CocaCola of the Internet. The champion of the online ad world, the Mountain View, Calif.based company now handles over 60 per cent of all Internet searches. “We believe that search is a natural monopoly business and expect that over time Google will continue to gain share until they have effectively reached 100 per cent,” wrote Heath Terry, an analyst with Credit Suisse, last November. So ubiquitous is the company that U.S. presidential candidates like Barack Obama and Hillary Clinton have taken note, making Google’s

headquarters an important campaign stop— “a photo opportunity at the most technologically advanced edge of the economy,” according to the New York Times.

All this has helped turn Google into a massive money-maker. The searches it handles, which the company links to paid ads, pushed Google’s profit last year to an estimated $5 billion (and online ad sales are only expected to grow). At $700 per share, the company’s worth is over $220 billion, almost as much as Warren Buffett’s Berkshire Hathaway. Even relative to Google’s handsome earnings, that’s an awful lot. Its price-to-earnings ratio is over 50. The average for a U.S. company: closer to 15. Numbers like that should raise legitimate red flags, especially for rational valueinvestor types who are all about price. “The major concern for a value investor is that it’s priced to grow as fast as it has been over the past few years,” says Jim Chuong, who runs Chuong Investment Management Fund in Toronto. The share price may well keep climbing, he adds, but its current value is high.

So is Google really worth more than $220 billion? That depends in part on what you think Google does. For those who see it as a simple online Web-search company, perhaps not. Sustaining the phenomenal growth it has enjoyed in Internet search alone will be tough. But pigeonholing Google like that is a mistake, says Stephen Arnold, the author

of two books on the company, who watches its patent applications closely. Almost since the time the company began, it has been plotting much bigger things, he says. The first clear clue as to what that might be came in November, when Google released cellphone software that will allow it to deliver, wirelessly, its ad-supported searches.

Already, big cellphone makers and leading carriers in japan, China, India and Germany have signed on. And many observers are almost giddy at the prospect of Google morphing into a major telecommunications player. “The growth for mobile phone advertising is

like a skyrocket,” says Arnold. “It doesn’t matter whose numbers you use. If Google gets 10 per cent of [the market], it’s another billion dollars.” Google’s only risk now is moving too slowly into wireless, says venture capitalist Paul Kedrosky. “You have to think from the standpoint of Google as a media company, not a technology company,” he says. “Where do they want to put their ads? They want to put them wherever you are.” U.S. wireless companies like AT&T and Verizon are also warming to this new Google, and have said they will open up and allow any handset to operate on their networks (paving the way for the spread of all kinds of Google-powered phones and giving the company a huge foot in the wireless door). In case phone companies haven’t got the message about Google’s plans, the company has said it also intends to bid for its own piece of the

U.S. wireless spectrum in 2008. Win or lose at auction, Google has fired off a loud warning shot, say observers.

This could be just the first step toward a Google that is a lot more than a website. “What it comes down to is the company regards the Web environment as an enabling mechanism for just about everything,” says Charles King, principal analyst with the research firm Pund-IT. Google could apply its business model (and computing power) to everything from banking marketplaces to virtual retail shopping malls. Exactly what these systems might look like is the topic of some speculation, but if there’s a way to organize and disseminate information and deliver ads to

‘THOSE BOYS ARE IN A SPOT NO ONE’S BEEN IN SINCE CARNEGIE DID STEEL. IT’S A NATURAL MONOPOLY.’

people wherever they may be in the process, Google seems poised to do it. What it all might be worth, nobody really knows, but most agree it is potentially huge. “Those boys are in a spot no other company has been in since the phone companies started or since Carnegie did steel,” says Arnold. “It’s a natural monopoly that is unfolding and no one has been able to rein it in.”

That’s not to say people aren’t trying. “Any time a company dominates a local field, it ends up with a very large target painted on its back,” says King. Google, he adds “is the subject of fierce competition.” So far, even its most serious competitor, Microsoft, has been playing a game of catch-up, spending billions to try to duplicate Google’s sprawling Web-based system and get a bigger share of the online ad pie, says Arnold. And most observers have been talking more about Google’s push into Microsoft’s domain—offering free Web-based office software that competes

directly with Microsoft’s products. Microsoft is still the largest tech company, with a market cap of about $320 billion, but if current growth trends continue, Google could easily grab that title within a year.

The most serious questions about Google’s long-term viability (and value) centre on its tendency to rush off in too many directions at once, pumping out new services and products as quickly as its army of young engineers can dream them up. Late last year, it said it would start developing renewable energy alternatives for coal. Admirable, but also laughable to many who wondered what that has to do with Google’s real business. The company famously lets engineers spend 20 per cent of their time working on whatever project interests them—which is either brilliant, or a recipe for mass confusion. Still, even if Google fails miserably in one of its endeavours, it can afford to. “Google is such an amorphous company,” says King. It’s also flush with cash (about $12 billion worth), and patient with its acquisitions. It bought YouTube in 2006 for a hefty $1.65 billion. YouTube still doesn’t make money, but Google isn’t panicking yet.

Despite Google’s grand designs, it would be risky to put too much faith in the analysts. “No one has any idea what Google is worth, not even Wall Street’s top professionals,” wrote former tech analyst Henry Blodget on the website Silicon Alley Insider. “They’re just gazing into the same hazy future as you are.” Even seemingly little things could sway the short-term price of Google’s stock. The Hollywood writers’ strike, for instance, could drive more advertisers online and boost Google’s results even higher next quarter, says Kedrosky. Conversely, he adds, the crisis in the U.S. real estate industry—a big buyer of online ads—could cause trouble. Google’s share price could hit $1,000, or-just as plausible—it could drop to $300, writes Blodget. “All other companies miss quarters and the overall market is tanking—so why should Google be immune?”

A good question. But immune is exactly what Google has been for the past three years. Ultimately, Google is worth what the market says it is, and most investors think it’s worth more and more. Who can blame them? Lately, even Mother Nature is going out of her way not to rain on Google’s party. M