The 8.45% drop of share price last week has pulled Google (GOOG) down to earth and reminded investors that its 39% surge in share price between mid-June and early October to an all-time-high of $774.38 was just due to the fantasy of some investors. Those who said earlier this month that Google will go up further have just overlooked the fact that the exit of its search engine from China early in 2010 has already crippled its long-term share performance and will hurt its revenue growth in a few years time.
Investors Overlooked The Sea Change of China's Search Market
Google's recent share price surge started in mid-June and surpassed the internet index (DJUSNS) in early August. This bull run did not end until early October just because most investors overlooked a significant development - the share price of Qihoo 360 (QIHU), the top Chinese provider of Internet and mobile security products, surged in mid-August, while that of Baidu (BIDU), China's No.1 search engine, plummeted.
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Figure 1: Google's 1 Year Share Performance
Such share price change between the two Chinese peers was against the backdrop of Qihoo, which launched its first searching engine in early August and proved to be an instant success--its search market share rocketed to nearly 10% within one month after its launch, mostly at the expense of Baidu. The development was widely documented but most Google investors took no notice of that and hence Google's share price surge remained intact. They are wrong: Qihoo's search engine has also hit Google hard.
Google Hard-Hit In China On Multiple-Front
According to CNZZ, Google's search market share in China in July (just before the launch of Qihoo engine) was 5.77%, ranked third, below that of Baidu's 81.54% and Shougou's 7.49%.
Yet, by Friday (October 19), Google's ranking dropped to 4th at 4.12%. It was also a far cry from a year ago when its share was at 7.41%. Baidu remained the 1st but its share dropped to 73.48%, Qihu surged to 2nd at 9.79% while Shougou dropped to 7.81%. As Google's market share is now below the important 5% threshold, there is a high possibility that it will soon descend into irrelevance.
The drop of Google's search business is just the most obvious sign of its China business in a death spiral. According to Analysis, Google's share of China's mobile map market also dropped to 17.5% in the second quarter from 23.2% in the first quarter, nearly caught up by Baidu which stood at 17.3%, and far below market leader Amap's 25.7%. Google's drastic drop is due to its license problem that makes the current version unable to update and its service unstable.
Google's poor relation with Beijing means its other businesses also face unexpected hurdles. The most obvious example is its acquisition of Motorola Mobile. Although both Google and Motorola Mobile are American companies, the mere fact that China is major market for the products of both of them means this acquisition needed Beijing's approval. The result is bad for Google: it took more than six months before Google got the nod from Beijing, with a condition that it had to provide updated versions of Android to Chinese cell phone makers for at least another five years, giving its competitors like Baidu and Alibaba enough time to develop their own smartphone OS. With China becoming the world's biggest market for ever-more businesses, Google is expected to face more hurdles in virtually all its business.
Potential Revenue Loss In China
So far, Google's poor relations with Beijing has not affected its revenue much because China's market has been insignificant for Google. Yet, in view of popular forecasts that China will surpass the US as the world's largest economy in five years, Google's potential revenue loss in China is huge. To estimate Google's potential revenue loss in China, I make two assumptions: 1) Despite its drive for business diversification, the lion-share of Google's revenue comes from its search engine. So, I just count on Google's potential loss in China's search market; 2) China's search market in 2017 will be comparable to that of the US in 2012 in view of its lower internet penetration and late development; 3) Google would have kept its 35% share in China's search market before it made the disastrous decision of pulling its search engine out of China in early 2010.
According to eMarketer's forecast, the US search ad market in 2012 would be $17.58 billion. Based on the above-mentioned assumptions, China's search ad market in 2017 would be of similar size. Google's potential search ad revenue loss in 2017 would then be $5.274 billion (35% minus 5% of $17.58 billion) or $16.12 per share. With a P/S ratio of 5.1 by the end of 2011, Google's potential revenue loss in China in 2017 means a potential loss of $82.2 in share price.
Google's sharp rise in share price in recent months has masked two persistent share price trends ever since the exit of its search engine from China in early 2010:
1) Google's share price has been range-bounded: within +/-20%, grossly outperformed by its main Chinese competitor Baidu which maintains a huge share price appreciation compared with the early 2010 level.
2) Google's share price has been moving in tandem with DJUSNS. This is not unexpected as Google, just like its American peers, have revenues mainly from the US market and has no foreseeable prospect of breaking into China's market.
Figure 3: Google's Share Price Performance Since Early 2010
My estimation of Google's potential revenue loss of $5.274 billion by 2017 is significant but not essential for the US search giant. However, with China's fast growing market and corresponding clout, Google will increasingly find its hands tied in all businesses due to its poor relations with Beijing.