When Google (NASDAQ:GOOG) revealed that it would drop a cool $1 billion for a mere 5% of Time Warner’s (NYSE:TWX) AOL, my first instinct was to shake my head. I know, I know, Google was defending a big swatch of revenue, but come on. To justify its current valuation, even after its recent PE haircut, Google must be spending for the future, not just defending its past success.
I have been mulling this over for awhile now (I know, prompt reporting) and looked into AOL’s history to see where Google’s $20 billion valuation of AOL falls in the grand scheme of things. A quick check at Wikipedia informed me that, at its peak, AOL was valued at more than $200 billion. That makes the $1 billion Google paid seem like a pittance, that is, if today’s AOL weren’t a shadow of its former self. With AOL losing some 90% of its value since being acquired by Time Warner, I wondered, could the same thing happen to Google?
It’s impossible to know, but some of the parallels are striking. In the 1990’s, AOL was a world beater. Synonymous with internet access, AOL truly did change the world, and the rise of its stock reflected it. AOL didn’t invent the internet, it popularized, monetized it and profited. The same can be said for Google with internet advertising. While Yahoo subsidiary Overture invented paid search, Google has dominated it. Google has ushered advertisers to spend their dollars online by proving that internet advertising leads to sales.
Internet advertising has exploded, bringing Google along for the rocket ride. Just like AOL’s dial-up subscription service, paid search is a cash cow. I fear though, that much like AOL, Google’s position is not defensible. AOL was slow to react to the changing landscape of its business. It was slow to offer a broadband service and subscribers left. Competitors lowered prices, and people left. In order to maintain subscription prices, AOL tried offering premium services, spending millions just to stop the bleeding.
Could the same thing happen to Google? The market certainly doesn’t seem to think so. Google is priced to perfection. No, scratch that, Google is priced to take over the world.
So how is paid search evolving? Is there a broadband boogie waiting in Google’s future? I think there could be. One of the major trends that Google is riding is the increasing interest in paid search terms. With Google’s auction system for keywords, increased interest translates to higher prices for the most sought after terms. This spells gravy for Google right now, but it also poses an inherent problem. As prices rise, those who are outbid for popular terms like “news” or “sandwiches” are going to search for other avenues to advertise (pun intended.) Enter competition. Google cannot grow advertising forever as there will always be a limited number of search terms to sell. Google will enable competition and will not be the lone search giant for long.
True, Google is the hotspot for search right now, but this could also change. While Google’s search platform is pretty slick now, there is always the risk that someone will leapfrog them and become the next it search engine. Or if not displace them, offer an alternative. Yahoo rolled out its revamped Panama search platform that should pretty much work the same as Google’s. Why am I spending so much time on paid search? Can’t Google grow in other areas? Well, yes, but search is their only area of defensible advantage. People search with Google, so advertisers will pay more to advertise with them. Google’s AdSense program is easily duplicated. We have already seen the affects of increased traffic acquisition costs on the bottom line during the recent quarter. While Google met estimates for revenue, Google had to return more money to their ad-hosting sites which ate into their bottom line. This is a trend that will continue.
I know, I know, Google knows this. That’s why they are spending billions on Gmail, Google Talk and Google Earth in order to be more than just a search engine. The problem is that none of these generate substantial revenue. This reminds me of AOL spending to add premium services in order to defend its deteriorating market share.
So will Google be the next world beater to be beaten? Will Google go done in history as the next Microsoft or the next AOL? Who knows, but I wouldn’t bet against the later. Google is spending money like a kid with a $20 in a candy story. They are tossing bills around with no rhyme or reason.
Google needs to focus on earnings and not on senseless innovation that might be cool, but doesn’t fit into their business model. Google is the “it” technology stock now, and that may continue, but a company can’t stay “it” forever.
GOOG 1-yr chart