Why We Own Google: How Suite It Is

Google (GOOG) is written about by the press, covered by over 40 sell side analysts and now by me. There is always so much news about Google including a recent analyst upgrade somewhat due to valuation. We own the stock based on a variety of quantitative factors. The investment thesis presented below which goes beyond the comparable fundamental data are based on my own observations.

Here are some facts I believe are relevant:

• In January, Google's share of U.S. online searches rose to 47.5%, according to comScore Networks Inc.
• Friendster Inc. announced that is has signed a multiyear agreement to carry advertisements by Google a new mega venue for ads.
• The YouTube controversy further separates those hanging on to old concepts and the way business is performed online. It is also making lots of press thereby adding millions of page views, many of which contain Adwords (ads by Google).
• Google is getting even more efficient now stating that for every 10,000 clicks on AdWords ads, the number of advertiser submitted invalid clicks claims (click fraud) that Google agrees to reimburse is now down to less than two or 0.02%.
• Goolge's revenue growth this most recent quarter of 67% dwarfs nearest competitor Yahoo's (YHOO) 13.40% and it makes money more efficiently with a trailing 12 month operating margin of 33.48% compared to Yahoo's 14.64%.
• If we were to view Google as a software firm, Microsoft's revenue growth was 6.0% this most recently reported quarter and its operating margin was an impressive 36.20%.
• At the end of 2006, Google had a growing war chest of $11.2 billion in cash and marketable securities on its balance sheet, up around 40% from 2005.

Looking over the next 12 months I see a new strategic advantage: Google Apps. This firmly enters Google into the very sticky revenue side of the business: subscriptions. At first glance it appears to be a take-away business strategy from soon to be direct rival Microsoft (MSFT), but initially that is almost "just for fun" revenue. Google's killer application: none. Google's Apps are not better than Microsoft's. Google will win and take a material amount of market share based on common sense, affordability, ubiquity and marketing.

There are thousands of people who work from home offices, but they don't work alone. There are road warriors, desk jockeys, creatives and suits. Like it or not every category collaborates and delivers with customers, the home office, vendors and a host of others. Microsoft has taught us how to: save files, version control, create folders and subfolders and how to collaborate with teams and our boss or client. True, Apple (AAPL) does every one of these tasks better. But, as one of the installed base of 450 million Windows users, that is how most of us learned (full disclosure: at home I have and use both a Mac and PC).

Does Google seek to take material market share away from Microsoft? There can't be news out of the Googolplex that could convince me otherwise. The "other" by product of this effort is dominance of the desktop and adding a material number of additional opportunities to have Google Apps users, perform searches, use other Google applications and see and click on ads.

It is this powerful combination of ads and subscriptions that is an incredible business model with sustainable revenue and no end in sight for its growth.

Common Sense
Let's assume that some smart folks at Google know what features most users want from the Office Suite and are working on an upgrade path. Let's also assume they will leap frog some annoying features and add intuitive on-line collaboration tools that they may not be thinking about in Redmond. Through the browser the first application I can eliminate is Outlook. I live on this program. I open in the morning through the browser and feel so grateful that I can access a pseudo-version from home. Security is always an issue, and I trust Google more than any corporate network of my past. My email and calendar are now moving to Google Apps, and I do feel good about it. One look, one version for calendar, rolodex and email. Home, office or visiting will never need to be synced because they are the same. The web makes sense for me and my mobile virtual world. Microsoft also has its "hosted applications" services. They immediately lose out when reading my next topic-line.

Affordability
For $50 per year per user Google Apps Premier edition is ours, all ours. A comparably equipped Microsoft Office version for an admin costs about the same amount as the PC hardware without a monitor.

Ubiquity
Now that Google is a verb and my six year old knows advanced search techniques her natural inclination is to the brand. Google's instinctive ease of use is already training the next generation of users. She will learn Docs & Spreadsheets along side Word, Excel and of course PowerPoint.

Microsoft doesn't offer Word and Excel hosted, but to be fair Google doesn't currently have a competitive product to Powerpoint either. Google offers BlackBerry support for Gmail and APIs to integrate the existing data and to communicate with other applications. Google also plans a network of partners and developers around Google Apps. All this will improve and without needing massive new versions to be introduced. A weak spot is that phone support is only for IT administrators, not for users. Most early-ish adopters are software and web savvy enough to not need much support.

Marketing
Google's balance sheet is certainly muscular enough to set an advertising campaign to rival Microsoft, but the three amigos running Google do not work that way. They start with a free app and then suck users in. Web 2.0 is at work with online real-time collaboration. The spend can be there if they want it but I'm sure they would take a zero or two off Vista's launch budget.

Summing it Up
My concern is if Google fully understands the implications of what it has created? The release of Vista has prompted IT departments to review their software migration paths. Some major firms and government agencies are openly discussing using Google Apps. This includes the US Department of Transportation, the Federal Aviation Administration and Japan's Ministry of Economy and Trade which is soon due to replace ~400,000 public school computers. Do they really want them all installed with MS Office?

For me, I'll keep using PowerPoint and integrate Google Apps. As a shareholder, I believe they are Apps to succeed.

Disclosure: Google Inc. (GOOG) is held in the Clear Large Cap Growth portfolio which is managed on a separate account platform. Mr. Corn is the founder and CEO of Clear Asset Management LLC and owns (GOOG) directly through his investment in the Clear Large Cap Growth portfolio.

Comments

[Douglas Reimer]

I would like to offer another angle on Google Apps for students at schools/colleges/unive... worldwide:

Google Apps especially Gmail / Gcalendar should be something every university/college/sch... in the world should be considering:
1. for new students - it's a no brainer
2. need migration tools for existing POP / IMAP emails for many returning students
3. need migration tool for MS-Exchange for all staff and teachers/professors (This would create a real MS Office war)

My experience is most students have Hotmail or Yahoo emails and continue to use them once employed.
Now that Gmail is generally available this may change.

Google should want to convert all students to use Google Apps not just Gmail because:
a) if Google offered their premium service, currently $50/seat/year, for free or a smaller fee to colleges/universities, etc. they will create a huge aftermarket
b) also takes marketshare from MSN and Yahoo
c) once employed these students will expose their new employer to Google Apps
d) huge subscription potential revenue
e) great positive publicity for Google

Maybe you could offer this "advice" publicly:
a) to Google
b) and bash Yahoo for not doing the same
c) and predict MS will do the same, after it's too late

Other thoughts:
a) collaborative homework and team projects
b) integration with search for reference material
c) calendars of classes/events available to all students/staff for each
school department
d) huge range of potential automation tools for faculty to evaluate/grade
essays and other homework
e) YouTube video classes/courses
f) students could be physically anywhere in the world
g) with Google Translation, interaction in many languages

Disclosure: Don't own any GOOG, don't know anybody at Google and haven't seen any internal Google plans.

Cheers... Douglas

2007 Mar 09 02:17 PM

[Douglas Reimer]

I would like to suggest Google Apps Premium Edition - for schools, colleges and universities worldwide:

Google Apps for Schools is free and is something every school in the world should be considering. It provides Gmail, Gtalk and Gcalendar. Google Docs, Spreadsheets and Page Creator, allows creation, sharing and collaboration on documents and web pages in real-time. Integration with existing IT and easy bulk account management is also provided.
1. for new students - it's a no brainer
2. for many returning students, need migration tools for existing POP / IMAP emails
3. for staff and teachers/professors, need a migration tool for MS-Exchange and Lotus Notes. This would create a real MS Office war.

My experience is that students have Hotmail or Yahoo emails and continue to
use them once employed. Now that Gmail is generally available, this may change.

Google should want to convert all students to use Google Apps because they:
a) will create a huge aftermarket – mind share
b) takes market share from MSN and Yahoo
c) once employed, these students will expose their new employer to Google Apps
d) large subscription potential revenue for a premium edition
e) positive publicity for Google

Other thoughts on student and teacher productivity for a premium edition:
a) integration with search for reference material
b) automation tools for faculty to evaluate/grade essays and other homework
c) integration with YouTube for video classes and courses
d) integration with Google Translation to allow interaction in many languages
e) collaboration with tech savvy parents

Maybe you could offer this "advice" publicly:
a) to Google
b) and bash Yahoo for not doing the same
c) and predict MS will do the same, after it's too late

Disclosure: Don't own any GOOG, don't know anybody at Google and haven't seen any internal Google plans.

2007 Mar 09 11:21 PM

[Sr. Pessimist]

One more benefit Google has is their purported positive treatment of their employees. They were supposedly ranked very highly in the top corporations to work. If there ever comes a time for most talented workers to have a better use for their labor services, Google won't be as bad off as others. Coming up shortly, for instance, the American economy will be desperate for the skilled labor it takes to perform software work. Demand will go through the roof for competent, reliable workers. The foreign countries that receive outsourcing just can't justify the profitability of taking on any more labor. Now their workers can just pick and choose what they want to do. In India, there is so much good work to do, nobody really wants to bother processing work visas. That's something for us Americans to do, with our healthy, booming Bushed-up economy.

2007 Mar 10 10:45 AM

[shashankkotike]

I WANT TO DO ONLINE JOBS. DO U HAVE ANY OF SUCH JOBS?

2007 Mar 30 11:33 AM