Google at $300? Hold That Cringe


By Ben Elgin Ten months ago, Google (GOOG) lived in the Street's doghouse. As it raced toward its August initial public offering, Google's unorthodox auction-style stock sale turned off big investors.Also, questions proliferated regarding its founders: Had they chagrined regulators with a Playboy interview published during the outfit's pre-IPO quiet period? And what of their vow to would-be investors that Google would issue no financial guidance, as most public companies do. By the time the company went public, its reputation was bruised, and its asking price slashed by roughly 30%, to $85 per share.

HOW HIGH? That was then. Wall Street's hand-wringing has since given way to applause. And why not? In its first three quarters as a public company, Google has bested consensus profit estimates each quarter by 20% to 40%. As mammoth competitors Yahoo! (YHOO) and Microsoft (MSFT) pour money into ad campaigns, Google has effortlessly extended its search-market lead by relying on word-of-mouth buzz.

And while its stock price has rocketed 226%, to $277, several analysts and investors think it has plenty of upside left. On May 31, Piper Jaffray became the latest investment bank to slap a $300 price target on the search kingpin. That would put Google's market capitalization at a staggering $83 billion, dwarfing corporate titans from Boeing (BA) to Ford (F) to McDonald's (MCD).

For many, the thought of $300 Internet stocks elicits visions of another helium-filled bubble, vulnerable to the slightest prick of a pin. Much like Henry Blodget's infamous $400 target on Amazon in 1998 (which, by the way, quickly came true), could these lofty expectations surrounding Google be an indication of industry hype eclipsing reality?

LEAPS AND BOUNDS. Sure, Google's stock comes steeped in risk. But the boosters make a surprisingly solid case. By some metrics, Google is actually inexpensive when stacked up against its closest competitors. While Yahoo's 2005 price-earnings ratio is 65, Google trades at 54 times its expected earnings. That makes it closer to eBay's (EBAY) p-e of 49.

"In absolute terms, yes, Google is very expensive," says John Tinker, an analyst at ThinkEquity Partners, which has a $330 target for Google. "But when you factor in the growth rate, it's actually quite cheap."

Indeed, Google's core business of Internet search shows little sign of decline. Net profits, which jumped 277% last year, are expected to climb an additional 250% this year, to $1.4 billion. Google's share of Internet searches continues to grow, reaching 36.4% in March, according to comScore Media Metrix. That's up from 35.9% a year ago -- and doesn't include key international markets, from Spain to China, where Google is doing very well, thank you.

PRICE HIKES? What's more, the prices of keywords, despite complaints by bulk buyers such as eBay, continue to escalate. Fathom Online, a search marketing firm that tracks keyword prices, estimates that they've climbed above holiday-season levels, rising 9% in April alone. Although Google doesn't disclose what percentage of its business comes from search keywords, it far and away ranks as its biggest.

Google also touts some powerful advantages in this business, which it has yet to exploit. Take its minimum-bid price, which Google charges for keyword ads. The starting price now sits at 5 cents per click for most places in the world, including the U.S. Some analysts and investors, however, believe that Google could raise that minimum bid to 10 cents per click, dramatically boosting revenues, without losing too many marketing customers.

Such a move would lift Google's top line by about 30%, according to James Callinan, a portfolio manager at Google shareholder RS Investments. "Google has all of these levers that they can still pull," he says.

LOFTY PERSPECTIVE. Perhaps more intriguing, however, is Google's foray into new products and services. In April it announced it would test so-called display ads -- image-based ads, such as banners -- on sites of its publishing partners. It's a dramatic shift for Google, which has built a booming business on sparse, relevant text-based ads that adorn search-results pages or news stories on partner sites.

Although it's just a toe in the water for Google, display ads constitute a massive business long dominated by portals such as Yahoo and Microsoft's MSN. The U.S. market for such display ads is expected to jump 27%, to $2.3 billion, in 2005, according to online researcher eMarketer. That approaches the anticipated 40% growth clip for U.S. search ads this year.

Google is also threatening to horn in on the territory of its portal competitors. The search giant has been the first to market with a mapping feature that includes satellite-photo imagery. This could turn into a powerful tool in the promising area of local search. Instead of typical online maps, the satellite images can show viewers the exact location or building that they seek. And Google is working on a feature that takes viewers on an aerial tour of driving directions, showing them exactly how to get from one place to another.

GROWING FAITH. Despite the promising developments, the stock still comes with plenty of risk. For starters, Google is a one-dimensional business, with nearly 98% of revenues coming from simple text-based ads that mostly adorn search-results pages. Yahoo, by contrast, boasts sizable search- and display-ad businesses, not to mention myriad subscription services, from online personals to fantasy sports.

If the search market slows unexpectedly, Google will struggle mightily. In addition, it still offers zero financial guidance. This may have contributed to the pleasant quarterly surprises. But such guesswork always has a downside. Says ThinkEquity's Tinker: "It's getting harder for Google now, as people are beginning to believe."

And $300 is still a very big number to believe in. Elgin is a correspondent in BusinessWeek's Silicon Valley bureau


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