We've updated the Trefis price estimate for Google (GOOG) from $659 to $703, up about 7% based on trends highlighted in Google's recent annual results. As expected, Google's discussion of its full year results highlighted the on-going trend toward more mobile searches and Google's entry into the mobile phone market.
We believe there are two interesting developments in Google's business that have not received as much attention:
1. Significant Cuts to Capital Expenditures
Google reduced its capital expenditures by nearly 66% in 2009 to $0.8 billion, which represents the lowest annual capital expenditure figure since 2005. Looking at capital expenditure as a percentage of EBITDA (essentially a measure of profits), the 2009 expenditure represents about 8% of Google's EBITDA which is much lower than historical amounts that range from 25% to 40% of EBITDA.
Google had high capital expenditures in 2007-08, during which it built data centers in four US markets. During 2009, Google had sufficient data center capacity and opted to delay the construction of a planned data center in Pryor, Oklahoma. The company mentioned in its earnings that it is very satisfied with its 2009 capital expenditures and plans to remain disciplined going forward.
We expect that Google's capital expenditures will increase over the next two years to a level of about 24% of Google's EBITDA, down from our previous forecast of 25%. We believe that the on-going proliferation of internet content, much of which is cached by Google's systems, as well as Google's push into cloud storage through Google apps, will continue to create demand for new data center facilities.
However, Google's ability to cut capital expenditures as significantly as they did in 2009 suggests that long-term capital expenditures could be lower than our original forecast. Each 1% change in our forecast amounts to a $200-300 million change in annual capital expenditures and this downward revision of our prior forecast has about a 1% positive impact on the Trefis price estimate for Google.
You can see here how significant the upside to Google's stock could be if capital expenditures were to remain at 8% of EBITDA instead of increasing back to higher levels.
2. Improving Revenue Per Search
The revenue per search (RPS) figures implied from Google's reported results were better than we expected due to robust growth in paid clicks and cost-per-click. Paid clicks had a year over year growth of 13% and cost-per-click increased by 5% both for Google Search and Adsense for Search.
Our belief continues to be that growth in Google's RPS will be driven by increasing demand for the advertising keywords on Google's search platform. We believe that improvements in ad targeting and conversion rates will make keyword search advertising even more valuable for businesses which in turn will increase their willingness to bid higher for association of keywords with their ads.
2009 RPS was nearly $35 per 1,000 searches compared to the $34 we had estimated. We've increased our forecast for Google's RPS slightly based on this positive improvement and our update had about a 3% positive impact on the Trefis price estimate for Google.
Disclosure: No positions