Bloomberg News

Google-Apple Valuation Gap Widest Since 2005 on Ads

March 06, 2013

Google-Apple Valuation Gap Widest Since ’05 on Advertising

The Apple Inc. logo is displayed at the company's store at Hysan Development Co.'s Hysan Place mall in the Causeway Bay district of Hong Kong. Photographer: Lam Yik Fei/Bloomberg

Google Inc.’s prospects haven’t looked so promising to investors relative to Apple Inc. since before the iPhone was introduced.

Google’s shares, which climbed to a record yesterday, are now trading at 25 times profit, compared with a price-to- earnings ratio of less than 10 for Apple, according to data compiled by Bloomberg. That gap is at its widest since June 2005, two years before competition between the two companies in mobile devices began to intensify.

Investors are willing to pay more for each dollar of Google’s earnings relative to Apple amid optimism that Google, with more than 40 percent of the U.S. online-advertising market, will command even more of the $37.3 billion that businesses spend each year to reach Web audiences. Google also has used an alliance with Samsung Electronics Co. to gain share in mobile software, feeding the competitive threat weighing on Apple as investors await the next big product from the iPhone maker.

“There’s only one company benefiting from all the growth areas of the Internet -- be it video, mobile, local, social, display advertising,” said Sameet Sinha, an analyst at B Riley & Co. “Apple has just done well in devices, nothing else.”

Google fell less than 1 percent to $831.38 in New York, while Apple declined 1.3 percent to $425.66. Google’s U.S. shares have added 35 percent in the past 12 months. Apple has dropped 20 percent in the same period, though its market capitalization is still more than $100 billion higher than Google’s. Apple remains the world’s most-valuable company, followed by Exxon Mobil Corp. and Google.

Search, Mobile

Under Chief Executive Officer Larry Page, Google has extended a lead in Web search, boosting its share to 67 percent, and in smartphone software, where it commands 70 percent of the market. That helps the Mountain View, California-based company benefit from two big shifts -- the boom in tablets and smartphones away from traditional computers and the move toward digital advertising.

Apple is undergoing slowing revenue growth and narrowing margins amid accelerating mobile competition led by Samsung and other users of Google’s Android operating system. A year and a half after the death of co-founder Steve Jobs, Apple is working to release new products that can build on the successes of the iPod music player, the iPhone smartphone and the iPad tablet computer, which revolutionized their respective industries.

The changing fortunes underscore the strength and predictability of a growing advertising market, compared with consumer electronics. While ad prices can vary with the strength of the economy, there’s usually steady demand for ads generally. In consumer devices, Apple faces pressure to constantly come up with a new home run product, said Nabil Elsheshai, an analyst at Thrivent Financial for Lutherans, which holds Google stock.

Services, Devices

“It’s no coincidence that Google’s rise has coincided with Apple’s demise,” Elsheshai said. “Making money from services versus devices is growingly perceived as a better business model.”

The outlook for Google has improved since as recently as mid-2011 when the company’s shares were trading below $500. The stock came under pressure amid concern that the company would struggle to find growth outside search advertising while grappling with competition from Facebook Inc., Amazon.com Inc. and Apple. Also weighing on Google was regulatory scrutiny by the U.S. Federal Trade Commission, which at the time was embarking on a broad antitrust investigation of its business practices.

Smartphone Leadership

The tide has turned, with Google demonstrating an ability to expand swiftly into new businesses, mainly mobile advertising. Google will command 55 percent of the U.S. market for mobile-ad revenue this year and 57 percent in 2014, according to EMarketer Inc.

Google’s leadership in mobile has extended to the operating system. While smartphones using Android software made up more than two-thirds of the global market, Apple’s iOS software made up just 21 percent, according to IDC.

Android is free to manufacturing partners, and Google makes money from ads shown to users of the devices.

Apple has run into challenges in mobile in recent months, coinciding with its stock decline. In September, Apple replaced a pre-installed Google maps app with its own version that met with poor reviews and frustration among users. Apple fired the manager responsible for its troubled mapping software, people familiar with the matter said in November.

Apple Potential

While Apple might gain traction with budget-conscious consumers if it introduced a lower-priced iPhone, this type of handset would also have lower margins than Apple’s current devices and cannibalize sales from the high-end model, Adnaan Ahmad, an analyst at Berenberg Bank, wrote in a research report.

Apple is “damned if they do, damned if they don’t,” Ahmad said. He cut his rating to sell and lowered his price target to $360 from $800.

In the fiscal first quarter, Apple’s sales rose 18 percent to $54.5 billion, falling short of $54.9 billion, the average analyst estimate compiled by Bloomberg. It was the weakest sales increase in 14 quarters.

There’s no guarantee Google will remain investors’ favored stock. Apple Chief Executive Officer Tim Cook has said the company is exploring new TV-related products, and he has a team of engineers developing a wristwatch device, according to people with knowledge of the plans. A more robust Apple TV could add to revenue while spurring demand for other products, from apps to movies to high-end electronics. An iPhone-like watch could command margins in the neighborhood of 60 percent, according to a Bloomberg Industries analysis.

Google’s Growth

Google, for its part, is vulnerable in key areas. The company has yet to produce a hit product that would help it make good on the $12.4 billion acquisition last year of Motorola Mobility Holdings. The shift to mobile also has disadvantages because ads shown to handheld device users command lower prices than those appearing on personal computers.

Google’s U.S. sales growth slowed to 20 percent in the fourth quarter, from 23 percent in the preceding period. That suggests maturity in Google’s biggest market, analysts at RBC Capital Markets wrote in a research note in January.

For now, Google is expanding its dominance of search, which accounts for most of the company’s revenue. Google’s share of the U.S. search-advertising market will expand to 76 percent in 2014, according to EMarketer, from 75 percent last year, and less than 70 percent in 2009.

The company has bolstered revenue from its search service with new ad products. Last year the company ended its free product-search service and began to require online sellers to buy ads to get placement on its site. Last month, the company improved its service for buying ads on its search engine, helping companies manage bids for ads running at different locations and times.

Online Tailwinds

“The core business is strong and strategically you could make the case that they have a lot of opportunities,” said Ryan Jacob, chief investment officer at Jacob Asset Management, who oversees a $120 million portfolio, including Google shares.

In the market for display-based advertising, which includes banner ads, Google took the top spot from Facebook in 2012, while Yahoo! Inc. was No. 3, according to EMarketer. Google is expected to take 18 percent of the market this year and expand that to 21 percent in 2014.

Google still has room for growth. With its leadership growing across major markets, the company is particularly well positioned for the shift of ad dollars to digital.

Web-based advertising is the fastest-growing medium globally and should become the No. 2 category this year, with 20 percent of the market, surpassing the newspaper market, which will have 18 percent, according to ZenithOptimedia. Television still dominates, with 40 percent -- though Google is poised to encroach in that arena though YouTube, the leading online-video sharing service.

“There’s still huge organic growth for Google to penetrate,” said Michael Scanlon, an analyst at the John Hancock Asset Management. “You got this huge secular tailwind of things going from print and TV to online.”

To contact the reporter on this story: Brian Womack in San Francisco at bwomack1@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net


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