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Get Four
|  | JUNE 11, 2004
 SPECIAL REPORT By Scott Kessler Putting a Value on Google S&P takes a hard look at the search giant's fundamentals -- and at the valuations of its peers -- to find an answer Amid an enormous level of interest in the Google IPO -- from investors, the media, and seemingly every other person you talk to at cocktail parties -- we at Standard & Poor's Equity Research Services decided to take an unbiased look at the company and its competitive position (see BW Online, 6/11/04, "Google: What Lies Beyond Search?"), including commissioning a proprietary survey of Internet users (see BW Online, 6/14/04, "Search Users Weigh In on Google"). And we've also tried to address the question uppermost in everyone's mind: What's a reasonable valuation for Google? Here, we run some numbers to come up with a preliminary figure. (This article is an excerpt from the full report. Subscribers to Standard & Poor's Advisor Insight can access the full versions of the Google Pre-IPO Report and Search Engine Survey in .pdf format. Adobe Acrobat is required. Full .pdf versions of those reports can also be purchased directly at http://sandp.ecnext.com/ipo). Our preliminary 2004 estimates for Google are net revenues of $1.9 billion, gross profit of $1.6 billion, and EBITDA (earnings before interest, taxes, depreciation, and amortization) of $1.1 billion. We project the company's net revenues will rise 92%, on continued gains in advertising, with particular strength from third-party relationships (i.e., AdSense). However, based on a less favorable revenue mix, we expect the 2004 gross margin will narrow (to 85.7%, from 87.3%). We're also modeling for some narrowing of the EBITDA margin (to 61.4%, from 65.2%), as Google makes significant investments to develop and promote new offerings and grow internationally. Moreover, we believe its undertaking to issue stock and operate as a publicly traded company will require significant commitments in terms of general and administrative expenses.
As we said elsewhere in this report, we believe Google's primary competitor and most comparable peer is Yahoo! (YHOO ). Based on our 2004 forecasts, Yahoo recently traded at 14 times revenues, 21 times gross profit, and 46 times EBITDA. If Google were to trade between discounts and premiums to these multiples of 10%, its valuation would be $33 billion to $40 billion. PROS AND CONS. Our analysis does not include consideration of enterprise value, net income, or EPS multiples, because we don't believe we can currently project with any certainty the company's 2004 net cash and investments, corporate tax rate, or outstanding diluted shares. Following its IPO, we expect Google's cash and investments and share count to both increase, and its annual tax rate to decline. We believe the initial valuation range indicated above is reasonable. Google's positives, in our view, include significant domestic and international growth opportunities, substantial profitability, a healthy balance sheet that will be bolstered by its upcoming stock offering (we expect it to raise at least $2.7 billion), and notable earnings quality reflecting the company's conservative revenue-recognition policy and expensing of stock options. In fact, we expect Google's divergence between operating earnings and S&P Core Earnings (as measured in percentage terms) to be among the lowest of the hundreds of technology companies we cover analytically. In our opinion, potential risks include the possibility that the company's search technology and offerings will become commoditized, potential difficulties related to the development or introduction of new products and services, and formidable and increasing competition from the likes of Yahoo and Microsoft (MSFT ). SHOUTING DISTANCE. Moreover, Google has a limited operating history, expects to invest heavily in and "place major bets" on new initiatives, is and will continue after the IPO to be controlled by its founders, is employing a largely untested Dutch auction mechanism to distribute its shares, and may not provide business or financial information as detailed as that disseminated by other public companies. To sum up: Despite what we consider advanced technology, useful offerings, and a compelling business model, Google faces significant challenges, both in garnering user and customer acceptance of its services and from well-capitalized rivals. However, we expect Google's IPO to be a success for the company, and currently believe the stock will trade at multiples comparable to those of competitor and peer Yahoo. Note: Scott Kessler is a Standard & Poor's Equity Analyst. He has no affiliation with any company discussed in this article. He has no ownership interest in any company discussed in the article. Regarding Microsoft (MSFT ), Time Warner (TWX ), and Yahoo (YHOO ), affiliates of Standard & Poor's Securities Inc. received non-investment banking compensation from each of these companies during the past 12 months.  Analyst Kessler follows Internet software and services stocks for Standard & Poor's Equity Research Services All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
BW MALL
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