More Reasons to Worry About Google

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Includes: AAPL, GOOG, IBM
by: SoundView Technology Group

By Kris Tuttle

Google (NASDAQ:GOOG) is in the news again in a not-so-favorable light due to continued scrutiny and actions in Europe. We have written about this a few times and we have acknowledged it more as a nuisance so far.

However, a recent post over at Taylor Frigon discusses the shifts that occur for large industry players over time and suggests that the “topple rate” for the kings of the hill may be increasing.

In the last few week or so I’ve been thinking about some other long-term and big picture technology company shifts and some of the conclusions made me become incrementally worried about Google, at least in terms of what multiple to apply.

The key exploration that started off my line of thinking was IBM versus Sun Microsystems. IBM has faced some very serious shifts in their business and has managed to deal with them quite effectively, although in most cases over a multi-year period.

We were at IBM for the shift into professional services. It was a very hard sell at first. Few, if any customers, felt that IBM could be objective. But IBM brought in senior executives that understood the services business and perhaps most importantly they changed all their employee incentives to drive behavior. In the ensuing 10 years IBM built a huge, top quality services business that also helped them add to their software empire as well.

There were many major changes at IBM over the past 20 years including exiting the PC business and becoming an OEM supplier but the point we are left with regarding IBM is that they understand two things as deeply as any player in the market: technology and the enterprise business (we will come back to this vis a vis Google and Apple (NASDAQ:AAPL)).

What about Sun Microsystems? They famously didn’t make it despite their technology acumen and massive business success in the late-1990’s. We know that Sun didn’t understand software or services at all but they took the further step of deciding that they wouldn’t bother to learn about it either. So Sun soldiered on in a battle where the terrain, weapons and methods of fighting all changed but Sun didn’t. That’s why the story ended the way it did in contrast to IBM.

I’d say the critical problem at Sun was that they only understood technology deeply, and even then it was mostly hardware and server technology. Sun didn’t see things from an enterprise perspective. Nor did they have any consumer expertise. So at a very high level Sun was actually a feature and not a company. It sounds glib but I don’t think it is.

Sure, but that’s all ancient history now. What does it have to do with Google?

In looking over the landscape of companies we follow and have in our R2 Model Portfolio, company management and culture is a key aspect of our investment process. In fact, since it factors directly into the multiple investors should apply to future results, it’s perhaps the most important one.

Broadly speaking we’d say that Apple is a company that understands technology, both software and hardware, as well as any other company in the world. However they couple it with a design and consumer focus that is allowing them to gain market share in multiple areas all at the same time. Obviously their overall company execution, in terms of margins, delivery, and retail operations, has also been top-notch. So Apple deserves a higher-than-average multiple.

I’d be willing to say that Google understands the Internet better than any other company. This includes aspects like Cloud Computing, Open Source and Mobile Internet to be sure. They have exploited this so far with search and advertising. Fortunately for Google this is a massive, rapidly growing and high-margin market.

But what else?

Google does not have a deep appreciation for the enterprise or consumers. The success of something like Gmail or Google Apps has more to do with it being good technology offered for free or near-free rather than any great insight, marketing or design on Google’s part.

Results on the consumer side of their business are decidedly mixed at best. Wave was a dud. Buzz was a fiasco. Nexus One is a proof-of-concept more than anything else and we expect companies like Motorola (MOT) to make Android a success.

Again Android will succeed based on the fact that Google has delivered a high-quality, open technology platform for free.

Many of you may be saying “duh!” at this point. That’s who Google is! But I’m not sure if investors completely understand that the leadership and culture at Google may not serve them well as they move into new markets and start to compete with companies like Apple and IBM.

To me it argues for a some tempering of long-term growth expectations and the multiple applied to future results. We still “like Google” and rank them high in our coverage in many areas including Cloud Computing, Mobile Internet and even RealVR thanks to Google Earth, Maps and SketchUp.

Disclosure: Google is part of the Research 2.0 model portfolio.

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