Both the mass media and Google (NASDAQ:GOOG) would like you to believe that everything is going just fine, that Google's growth is strong and valuation of a search engine is justified at the market cap of 152 billion dollars. After a quick play with Google's own numbers you may be wondering why Eric Schmidt is "... ecstatic about our financial results this past quarter" particularly if "...I would like to remind everybody, as I have each year at this time, that we are about to enter our seasonally slower summer growth period, and make to sure you factor that in when thinking about how our business will grow."
So what is so "ecstatic"? Maybe it is EPS at 3.18 which is below EPS of 3.29 in Q4 2006. It is a decline in EPS of 3% and Google is facing its seasonally slowest quarters ahead. I found it rather disturbing that a company with a bubble valuation of Price/Sales=12.6, Price/Book=8.2, Price/Earnings=43.2 and Market cap to free cash flow ratio of 83 (!) has a slowing revenue growth rate -20% Y/Y. Google's own sites have a slowing growth rate-22% Y/Y and its network web sites revenue growth is falling even faster - 24% Y/Y. It is still one trick pony with licensing and other revenue at just one percent of its total revenue, and even at this low level rate of growth it is slowing Q/Q.
A portion of Google's own sites is rising in total revenue and the networks' share is falling with TAC rising. It is reflecting rising competition and distribution deals which are eating margins. At the conference call George Reyes said:
The answer is that we're doing a lot more deals and the deals are, in fact, carrying a disproportionate amount of TAC. So, at the end of the day and I think I suggested that in my earlier comments, TAC as a percentage of revenue is likely to increase given the deals that we're doing these days
Net income falls in Q1 2007 to 1,002,162 from 1,030,716 in Q4 2006 ('000USD) show declining Net Income margin from 32% to 27%. Sales per head are stagnating at the low end in the 2006 range at 299.4 ('000USD). All this analysis is based on GAAP figures presented by Google and accounts for all related expenses, including stock based compensation, as it should be done according to Warren Buffet, who is incidentally admired by Google founders. Regarding the latest corporate development Mark Mahaney of Citigroup asked:
... Secondly, a broader question just on display advertising. Larry and Sergey, when you started this search, you clearly had something different in mind, something more targeted than the normal advertising that was out there. What generally changed in your thinking that it made you think either that the display advertising market was big enough or that you had a targetable solution that was good enough to make you want to make the moves you made, like buy DoubleClick?
Sergey Brin replied:
...Advertisers, in many cases, don't have all the metrics information they need to decide which ads to run where. So we have seen good success with that, and we think we can expand that more to broader kinds of media, not just static images and what not. Of course, with this intent to acquire DoubleClick, we think we can make more advertisers much more efficient.
With such a flexible motto, privacy advocates will be alarmed. The deal in general seems to be based on an "overreaction" to the threat of losing DoubleClick to competitors, which resulted in a price tag of 3.1 billion cash offer from Google.
I would like to run a few parallels. It is estimated that DoubleClick had roughly 150 million in revenue last year, as reported by Wall Street Journal. So Google is paying 20.7 times sales of the company. Google itself is valued at the moment at Price/Sales=12.6, (Yahoo! (NASDAQ:YHOO) P/S=5.7, Microsoft (NASDAQ:MSFT) P/S=6.0), so Google is paying premium of 64% for DoubleClick above its own exaggerated valuation, which is 121% higher then their nearest competitor. By making a payment of 3.1 billion dollars, and buying a company with 150 million dollars in revenue, Google will lose interest income in the amount of 161.2 million dollars per year, assuming investments in money market funds at 5.2% p.a.
Most importantly, Google is spending almost 30% of available 11.2 billion dollars at the year end. With flat free cash flow (1.678 billion dollars in 2006 Vs 1.621 billion dollars in 2005), operational cash flow actually decreased by 9% in Q4 2006 from Q3 to 0.911 billion dollars) and with a pending lawsuit of 1.0 billion dollars, there is not so much money left to fight a competition war against Yahoo!, Microsoft and the Old Media Guys. With effect of the "law of big numbers" already shown in recent decline in EPS, its slowing growth rate will become apparent even to most devoted Google followers. The inability of this "technological" company to create any new products should ring alarm bells for any investor.
Disclosure: Author has a short position in GOOG