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By Scott Kessler The buzz surrounding the initial public offering of Net search leader Google is growing louder as the launch date draws closer (we at Standard & Poor's Equity Research Services expect it to happen sometime this summer, probably later in the season). Even Bill Gates has weighed in on the phenomenon: "Buy the stock -- whatever the price!" he joked at the D2: All Things Digital conference in early June.
The IPO will likely be one of the largest and most talked about stock-market debuts in history. The intense interest in Google's public debut led us to undertake an independent and unbiased evaluation of the search giant, including opinions on its competitive position. And we've also come up with a preliminary assessment of its possible stock valuation (see BW Online, 6/11/04, "Putting a Value on Google"). S&P intend to issue the second part of our report, covering the IPO's Dutch-auction process, along with further details on Google's valuation, by August.
(Editor's Note: This article is an excerpt from the full report. Subscibers to Standard & Poor's Advisor Insight can get 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).
DOMINANT SEARCH PLAYER. To better understand the online search category -- particularly its leader, Google -- we commissioned a proprietary survey of 1,000 Internet users nationwide in April, 2004 (see BW Online, 6/14/04, "Search Users Weigh In on Google"). We asked these users about their thoughts and usage regarding 15 online search services, ranging from America Online (a unit of Time Warner (TWX
; recent price, $17.17; S&P investment ranking, 4 STARS, or accumulate), AltaVista, and Ask Jeeves, to WebCrawler and Yahoo (YHOO
; $31.86; 3 STARS, hold). Some of the competitive industry analysis presented here are based on that survey's results.
The poll showed that Google is by far the most popular Internet search service, used by 48% of respondents. Yahoo's offering was a distant second, with one in five respondents indicating they use it most. The search service of Microsoft's (MSFT
; $25.96; 5 STARS, buy) MSN was the third-most popular, followed by those of America Online and Ask Jeeves. The order is largely in line with recent data from research outfits comScore Media Metrix and OneStat.com, giving us confidence in the validity of our survey and its results.
Although Google is the leader in U.S. online search, we believe that Yahoo has become a formidable competitor. Moreover, we think future success in the category and related segments will be greatly influenced by factors beyond online search assets. The framework of our examination is based on information presented by Yahoo at its 2004 Analyst Day, but our assessments and conclusions differ somewhat from those the portal presented.
HOME-PAGE HABIT. We think Google has the Internet's best current search technology, and according to our survey, 43% of online search users agree. Our survey indicates that while Google's use is motivated by the relevance and accuracy of its results, more than half the people use search offerings from AOL, MSN, and Yahoo because these services are their home pages -- or are part of their home pages -- or simply out of habit. Interestingly, neither America Online nor Microsoft currently own the search technology deployed on their sites: Google powers AOL's search services, while Yahoo provides MSN's capabilities.
Keeping its sights squarely on Google, Yahoo beefed up its search service by acquiring AltaVista, the Internet search business of Fast Search & Transfer, Inktomi, and Overture Services in 2003. After this service's relaunch in February, 2004, employing its newly constituted proprietary technology in place of Google's, Yahoo is poised to challenge Google in algorithmic search, in our view. One early victory: In May, 2004, Yahoo announced it won CNN as an algorithmic-search customer, replacing Google.
Yahoo's Overture Services created the sponsored-search category, but it lost a number of customers following Google's entry into the business in 2002, including America Online, Ask Jeeves, EarthLink (ELNK
; $10.25; accumulate), and Lycos. We also believe that Google has more sponsored-search customers than does Yahoo, which has retained MSN as a client. It's also worth noting that Yahoo has sued Google for alleged infringement of its sponsored-search technology.
WEAKNESS OUTSIDE THE CORE. Our survey indicates that Google has the leading Internet search brand. When asked to name a search service, half of the Internet users we surveyed said Google, followed by Yahoo, MSN, and AOL. This isn't surprising, given that the word Google has become synonymous with online search. We believe that as search offerings become more similar (i.e., commoditized) over time, brand will play a more pivotal role in attracting and keeping users.
However, because Google has established itself so indelibly in the search category, we think it could experience branding challenges as it expands into new segments. We believe this is why it didn't include its flagship brand in the names of some of its newer offerings: Froogle for comparison shopping, Orkut for social networking, and Gmail for e-mail. Although Google has an advantage over Yahoo, Microsoft, and AOL in terms of technology, user satisfaction, and brand strength in online search, we believe its positioning is not nearly as favorable when it comes to areas beyond this core segment.
Because of the nature of most of Google's consumer search services, the company has few registered users. The clear leader in that regard is Yahoo, with 141 million registered users at the end of the first quarter of 2004. AOL was a distant second, with 32 million, while No. 3 MSN had 8 million.
TOUGH REPLICATION. While this disparity doesn't seem to have had a negative impact on Google's growth and profitability so far, its ability to most effectively target advertising and monetize its offerings requires the establishment and enhancement of closer relationships with its users. Yahoo has an edge over Google, in our view, because it knows a great deal about its users, not only because of the registration information they provide but also because of the significant breadth and depth of Yahoo content (news, HotJobs, Yahoo Mail, Yahoo Messenger, etc.) that they consume.
While Google has a number of consumer offerings, most of them are focused on search. Google's foray into news and e-mail services seems intended to better position it to emulate Yahoo's strategy. But we think Google will have difficulty replicating Yahoo's success in consumer content and services.
We believe that while Google News garners millions of unique users per month, this is largely attributable to 41% of the outfit's users searching for news. With Froogle, Google has extended its search capabilities to comparative shopping. But users of Google search somewhat less for information about products and services than those of other major search services.
While Froogle is a single, focused application, Yahoo offers similar search functionality, as well as browsing capabilities, a shopping marketplace, and payment offerings. We believe Google's relatively narrow range of online shopping services puts it at somewhat of a disadvantage vs. some of its competitors, including Yahoo.
DIVERSITY IS KEY. Our research suggests Google will experience challenges with services that require users to provide personal information such as a name, a home address, or an e-mail address. For example, only 14% of Internet users would provide their e-mail addresses in order to receive automated search-result updates. And our survey suggests that only 23% of online users would sign up and regularly use Google's Gmail service. Google users were comparably unenthusiastic about these offerings. Moreover, Yahoo indicated it would increase the storage capacity for its free and market-leading e-mail service this summer.
In our view, having diversified online marketing offerings is crucial to the long-term success of any Internet media company. We believe advertisers have been increasingly pursuing multifaceted online marketing strategies to more effectively interact with Internet users.
Keyword search is the largest component of U.S. online advertising, and Google derives virtually all of its ad revenues from this category. The growth in that segment speaks for itself. Based on data from PricewaterhouseCoopers/IAB Internet Advertising Reports, the overall keyword search category generated $81 million in revenues in 2000, representing only 1% of overall online ad sales. Jump ahead to 2003, and keyword search accounted for $2.5 billion in revenues -- a hefty 35% of the total U.S. online ad-sales pie. And by 2005, S&P estimates that it will garner over $4 billion, and grow to 41% of the overall total.
However, AOL, MSN, and Yahoo all derive significant revenues from many other types of online advertising, including the second-largest category -- display ads (e.g., banners) -- and the fastest-growing segment -- rich media (which employs audio, video, or animation to foster greater user interest and interactivity). Google has started to offer branded advertising options to its Google Network customers to address this shortcoming, but its success in this endeavor is uncertain.
ISP LINK. The search giant also comes up short in terms of software offerings. AOL and Microsoft have their Internet software on computers around the world, from browsers, to media players, to messaging offerings (i.e., AOL Instant Messenger and MSN Messenger). This constitutes a significant competitive advantage over Google and Yahoo. While Yahoo has the Internet's second most-popular messenger product, according to comScore Media Metrix, Google's only notable foray into consumer software is the Google Toolbar.
Although our survey indicates that the significant opportunity for penetration is associated with search toolbars, all of the major players offer them. Increasingly, companies have been partnering to aid toolbar distribution. Over the past month or so, Google signed a deal with with RealNetworks (RNWK
; $6.11; 3 STARS, hold), and Yahoo aligned itself with Macromedia (MACR
; $24.75; 3 STARS) We expect this trend to continue beyond toolbars.
Perhaps more important from a distribution standpoint, in our view, is that AOL, Microsoft, and Yahoo all own or are affiliated with Internet service providers (ISPs), and their search services benefit as a result. Our survey indicated that the primary reason people use these companies' search offerings is because these services are their homes pages or are part of their home pages. Only 11% of Google users are motivated similarly.
GLOBAL REACH. That's why we expect Google will try to foster closer relationships with ISPs. It already has a relationship with EarthLink, and we believe an enhanced partnership between them would be mutually beneficial. However, we don't expect Google to use its IPO proceeds to acquire an ISP for a variety of reasons, including that such a transaction would severely reduce its profitability. We foresee Google pursuing alliances comparable to the linkup between Yahoo and SBC Communications (SBC
), for example.
One other challenge facing Google: Building a user base outside the U.S. We believe that global reach is important to Google's future because growth in international online users, usage, and advertising is becoming increasingly significant. Based on data from Nielsen/NetRatings, we believe that in terms of unique users, MSN is the world's leading online destination, offering content through 38 international Web sites. We see Yahoo as a close second, with more actively used online services that are available in some 20 countries and 13 languages.
Although Google has 95 international domains, and its interface is available in 97 languages, its global audience lags behind those of MSN and Yahoo. Moreover, the breadth of Google's international offerings is somewhat limited.
Where does Google stand as it prepares to set sail as a public company? The search king has some powerful things in its favor: advanced technology, useful offerings, strong brand, and a compelling business model. But it does face significant challenges. Although we foresee a successful near-term future for Google, we aren't as convinced as some other observers about its long-term prospects as it ventures beyond its core competency of search -- and faces increasing competition.
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, Time Warner, and Yahoo, affiliates of Standard& Poor's Securities Inc. received noninvestment-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