Microsoft's Bid for Yahoo: My Signal To Finally Buy Google

Dan writes:

I see you haven't bought Google (GOOG) yet, despite all your positive articles about it. When do you expect to buy, and will you put on your website when you actually place the order?

The Kelly Letter has owned Microsoft (MSFT) and Yahoo (YHOO) for years, and is sitting on modest profits in each. My reason for owning Microsoft was to capture upward momentum from its Windows/Office upgrade cycle that started last year; for owning Yahoo it was an eventual recovery as it streamlined and improved its competitive position against Google. I thought Yahoo was a bargain compared to Google, and didn't like Google's over-reliance on advertising for profits. Remember, some 99% of its profit is from ads.

When Google kept climbing last fall to $747 on November 7, it looked far too overpriced to me. Its MACD was over 37 and its relative strength was 86 -- both stratospheric and screaming for a correction. Part of that rally came from Jim Cramer, who in October raised his price target to $750 but called even that "a total and unequivocal lowball estimate" considering the growth potential. He said a more reasonable estimate was $900. He'll be right someday, but there was no way it was going straight there from early November's precarious peak.

So, my initial hesitation with Google was two-fold. One, I was betting on Yahoo to get itself back on track. Two, I was convinced that Google was overpriced and vulnerable to some kind of setback. I was not prescient enough to know that the market would crash as far as it did in January, nor that Google would be so punished for its slowing click rates and so on. Thus, some of the good timing was just luck (and always is, no matter what anybody tells you). However, when a stock is as out of oxygen as Google was last Fall, it doesn't take much to knock it down. I knew that, and held back until something happened to it.

Then, my attitude toward Google changed. What did it was Microsoft's bid for Yahoo. To me, that marked the end of Google's serious competition online because I believe that both Google and Yahoo are working on internet-based operating systems with the potential to make Windows unnecessary, and that that's the real reason behind Microsoft's buying Yahoo. It's not actually just about advertising -- although it is somewhat, of course -- it's really about bulking up for a long war against Google for control of software-as-a-service (SaaS) computing that's going to take the world by storm any year now.

I found on SnapSheet Monday the news that Google Apps's revenue has gone from $0 to $400 million in just three years. It's up ten-fold from just a year ago. Granted, $400 million is still a small figure compared with Microsoft Office's $18 billion revenue, but with its blistering rate of adoption, you can be sure Google Apps won't remain a mere annoying gnat for long. Also, have you used Google Apps or Docs? I already run my business with Google Docs and, let me tell you, it's fantastic.

Furthermore, I think Microsoft's proven ineptitude online is going to destroy or at least hobble whatever chance Yahoo had against Google. Thanks to Microsoft, Yahoo is on the same path to oblivion now sporting AOL's footprints. In a few years, I think we'll see the Microsoft/Yahoo conglomerate as an online dud with a smaller share of online search than they have now, an absurdly bloated online version of Office that's outflanked in every regard by Google Apps, and an operating system from Google that's a genuine alternative to Windows.

Aside from recent events, I'm fed up with Microsoft as an investment. Steve Ballmer is no Bill Gates, at least not judging by stock performance.

Microsoft has basically been dead money for five years. Since Steve Ballmer became president in January 2000, MSFT has lost about half its value. Now, he took over at the top of the internet bubble, but even if we clip off the bear market years and just examine the stock's price from, say, the beginning of September 2003, it's still down 4%. In that same time, the S&P 500 is up 30% -- even after the recent market trouble.

Given all of the above, The Kelly Letter is looking to sell both Microsoft and Yahoo at profits, and move the proceeds into Google at a cheap price.

We've been patient with Google and are hoping that investors see the Microsoft/Yahoo merger as a big threat to Google so that the GOOG share price keeps dropping. When it gets low enough, we'll begin buying.

Comments

[Cardboard Z...:]

Great article. How does GOOG plan on getting big biz to go with Google Apps and Google SaaS? This is an aspect of their biz that not many are aware of. Everyone knows about Google search domination. You bring up very good points. Well done.

2008 Mar 04 09:00 AM

[Tom B:]

"Aside from recent events, I'm fed up with Microsoft as an investment. Steve Ballmer is no Bill Gates, at least not judging by stock performance."

Your analysis is dead on. MSFT investors are living the past; although, clearly, MSFT still rakes in big bucks every quarter from the Enterprise IT department lemmings.

Ballmer is MSFT's version of Apple's John Sculley in the 1980's. And, though MSFT has never been penalized in a BIG way for their monopolistic behavior, they are now required to be less blatant; thus, less effective at it.

MSFT does not have the tools it needs to compete in the 21st century. They spent 5 years putting eye-candy on XP and calling it Vista. What they SHOULD have been doing is throwing out Windows rotting foundation and rebuilding Windows on top of a UNIX kernel. This could have helped with their persistent performance and security problems.

2008 Mar 04 09:11 AM

[Network Effect:]

If 90+% of operating systems are MSFT, how do you propose Google will generate enough critical mass to overcome the massive value of interoperability generated by MSFT's network of users? MSFT has been generating inferior technology for years. The value does not lie in the technology. The value lies in the network. Since MSFT owns the current network, converting them to an online service will be relatively easy, just like every past upgrade to the operating system. Google doesn't have a network, and they will be competing against one of the largest networks in the world. Google Apps may be a superior technology, and Google may be a great company, but they'll just be in a long line of superior technologies to MSFT and MSFT will continue to win because they own the network. Just look at Google Base and Google Wallet. They are also potentially superior technology to eBay and PayPal. However, they are trying to compete against an established network with massive inter-operability. And how are Google Base and Google Wallet doing? Again, the value is in the network, not the technology.

2008 Mar 04 09:37 AM

[Marl Balou:]

The $400 million revenue number for GOOG from Google Apps is suspect. This was quoted in an offhand manner by Techcrunch who attributed it to some "Google insider". This number has started getting a life of its own without anyone corroborating or verifying it.

2008 Mar 04 11:03 AM

[Alex Filonov:]

Good analysis, right on point! I thought similar things the day MSFT declared bid for YHOO (muddlinginvestor.blogs...),
but your article is much deeper.
Microsoft might be in a lot of trouble now. They seem ready to spend every penny and then some to fight Google. Doesn't seem like a good business plan to me.

2008 Mar 04 11:16 AM

[Relic37:]

Remember Lotus 123 and WordPerfect - both were Kings of their respective spreadsheet and word processing domains? Then along came Excel and Word, with the muscle of Microsoft and dethroned them both. Windows has become the ugly aunt you have to kiss at family reunions - you can hardly wait for her to die. I relish the thought of Google bumping Microsoft into the wastecan of historical footnotes. Now if Google and Apple would team up against Microsoft....

2008 Mar 04 11:53 AM

[TAREK:]

Waite untill the bid for the 700Mhz wireless end then decide if u will buy Google or not

2008 Mar 04 01:51 PM

[TA:]

Weren't you the guy telling everyone GOOG is going to $1500 and it's a steal $100 higher than it is now?

2008 Mar 04 01:53 PM

[Tom B:]

"Weren't you the guy telling everyone GOOG is going to $1500 "

It probably is. Not THIS year, though.

2008 Mar 04 01:56 PM

[TA:]

I found the quote

'Then again, without people like Eric, Google would be around $1,800 instead of this dirt cheap $502 nonsense.'

If it was dirt cheap at $502, why didn't you buy it already?

'When it gets low enough, we'll begin buying.' - so I guess $502 wasn't dirt cheap after all

What's low enough now? Why subscribe to your letter when I can get this quality of advice and flipfloping for free from Jim Cramer.

2008 Mar 04 05:17 PM