Google Shows Restraint, Fails to Outbid Microsoft for Facebook Ad Deal

With a flurry of deals in recent months, Google (GOOG) has seemed willing to pay handsomely for attractive companies and contracts. The online ad leader has received mixed reviews for acquisitions of Doubleclick, Feedburner, and YouTube, as well as their exclusive ad deal with MySpace. With news that Facebook was negotiating with both Google and Microsoft (MSFT) on an international ad deal and a minority investment, it would not have been surprising, given their cash hoard and past deal history, to see Google outbid Gates & Company for the deal, even though Microsoft currently runs ads on Facebook’s domestic site.

In a shift for Google, reports are hitting the wires that Facebook has secured a $240 million investment from Microsoft, in exchange for an expanded ad deal that covers Facebook’s foray into the international market. MSFT is getting a 1.6% stake, which values Facebook at a whopping $15 billion. All this for a company that supposedly is on track for 2007 revenue and profits of $150 million and $30 million, respectively. That’s right, Microsoft is paying 100 times 2007 sales and 500 times 2007 earnings!

There is no doubt that adding Facebook to its arsenal of web advertising properties would have been a boon for Google, but given that Microsoft already has a relationship with them, it is not too shocking that they would expand their existing deal. While prices of less than $2 billion for YouTube and $100 million for Feedburner will likely turn out to be bargains, it was likely tougher to justify a $15 billion valuation for Facebook. Many Google shareholders are probably happy to see the company show some sort of financial restraint, even though Facebook is clearly a hot property in the social networking space.

As for Google stock, the shares have soared to $675 on the heels of another strong quarterly earnings report from the company. I still believe the stock will continue its rise, but future gains will likely be far more limited. I will likely want to sell stock when the forward P/E approaches 35 times, which right now would equate to about $718 per share.

For the bears who continue to point to the fact that Google’s market cap has irrationally matched or exceeded that of blue chip companies like Citigroup (C) and Wal-Mart (WMT), I would caution people against such comparisons. Lining up a software company side by side with a retailer or a bank really is comparing apples to oranges. Instead, I would suggest you compare Google’s valuation with other software companies.

With a low 30’s forward P/E ratio, given Google earnings growth projections over the next 3 to 5 years, I think investors will conclude that Google’s share price is not only quite reasonable, but will continue to rise if the company can deliver earnings growth rates in the 20 to 30 percent range annually for the next several years. Even if you factor in decelerating profit growth as well as continued P/E contraction, you can still project a stock price meaningfully higher than current levels over the longer term.

Full Disclosure: Long shares of Google at the time of writing