Chowdhry’s analysis (and we have not seen the original full research note) has GOOG posting revenues of US$15.71 billion in 2008 (5% below actual 2007 revenues of US$16.94 billion), US$15.23 billion in 2009 (3% below his 2008 projection) and US$14.57 billion in 2010 (4% below his 2009 projection). This analysis was picked up by a range of commentators that we really respect. These included analysts like Barron’s Eric Savitz, Silicon Alley Insider and Ashkan Karbasfrooshan. The only problem is that the analysis is deeply flawed.
At Valuecruncher we believe that top-down analysis can lead to flawed conclusions. Current trends can be mistakenly extrapolated out. We believe that you need to work from the bottom up. This appears to be a case of top-down analysis gone wrong.
Chowdhry’s 2008 revenue number appears based on currently deteriorating macro conditions - remember 2008 revenues of US$15.71 billion. However, through three quarters of 2008 GOOG has reported US$16.09 billion of revenues (through three quarters). GOOG already has reported 2008 revenues above Chowdhry’s projection (through three quarters). Unless GOOG announces negative Q4 revenues it is not going to be posting revenues for the 2008 financial year of US$15.71 billion.
So what do we think about GOOG’s future revenues and the implications for valuation?
Valuecruncher produces a valuation of US$350.60 for GOOG. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 11.0% above the current share price of US$315.76.
- Revenue: Reuters aggregates 26 analysts covering GOOG and the mean estimates of 2008 and 2009 revenues are US$22.4 billion and US$27.9 billion respectively. For our analysis we have used US$21.5 billion in 2008, US$24.75 billion in 2009 and US$29.0 billion in 2010. Citi analyst Mark Mahaney has some assumptions around revenues that we are broadly in agreement with. Assuming Q4 revenues are in line with Q3 then 2008 revenues come in at US$21.635 billion.
- Profitability: We have used an EBITDA margin of 40.0% to 2010. Reuters has GOOG‘s EBITD margin at 36.4% last year and an average of 36.0% over the last five-years.
- Capital Expenditure: We have assumed capital expenditures of US$2.75 billion in 2008 then US$3.0 billion per annum moving forward.
- Discount Rate: 11.0%.
- Terminal Growth Rate: 5.5%. In our assumptions we have 2009/10 revenue growth at 17.2% - we have assumed that growth eventually slows to a 4.0% long-term stable growth rate.
Our analysis incorporates the cash on the GOOG balance sheet – Valuecruncher calculates a net debt number.
Comparator analysis (sometimes called comparison company analysis) is a relative valuation approach. For GOOG we looked at a two peer companies - Microsoft (MSFT) and Yahoo (YHOO). We calculated enterprise values - market capitalisation plus net debt (long-term borrowings less cash). Then we measured a range of metrics against the enterprise value for GOOG and the peer set.
We have used the last financial year [LFY] as the base set of metrics. Of the peer group YHOO is the closest direct competitor. But YHOO has had a number of recent struggles and its LFY performance against GOOG is not pretty. MSFT’s numbers are an interesting comparison. MSFT shows how far GOOG still has to go from a financial perspective. MSFT has over 3.6x the revenues of $GOOG (on a LFY basis).
MSFT’s financial performance is comparable to GOOG. The market is currently valuing the revenues, profits (EBIT and EBITDA) and free cash flow produced by MSFT at less than half that of the comparable numbers for GOOG. This reflects the perceived different future growth prospects of the two businesses. That is an interesting observation - but to properly understand the implications you need to do the bottom-up analysis for each (probably using a discounted cash flow model).