The Publishing Industry Should Have Learned from the RIAA

Just as the Recording Industry Association of America sued Napter in the late 1990’s, we now have the book publishers suing Google (GOOG) over digital book cataloging. The big point that the RIAA missed many years ago was that technology was changing the way people learn about, access, and listen to music.

CD sales have crumbled and the iPod has been invented. That’s quite a shift in 6 or 7 years. Had the RIAA adjusted to the shift back then, perhaps they could have better insulated themselves from the sales hit they have taken as traffic in Best Buy’s music aisles continues to diminish.

In hindsight, the RIAA should not have cared if they got their cut from the sale of a CD or the download of an album online. Unfortunately, those executives spent too much time huddled with their lawyers, and not in meetings figured out how to change with the times. With the success of iTunes, the recording industry is doing okay (online sales net them less money than a retail CD sale), but I’m sure they are still miffed at the digital revolution, and continue to spend time suing college students for illegal downloads.

It appears the publishing industry is going to follow the same lead, as seen from its lawsuit against Google for scanning copyrighted material. If we simply looked at the publishers’ reaction to the launch of Google Print, you would think Google is taking books, scanning them, and posting them on the Internet for everybody to read for free. The funny part is they are doing nothing of the sort.

Google is organizing book titles and creating an online reference tool for searching the world’s vast array of published works. Think of it as a digital card catalog, but rather than just your local library’s collection, it encompasses (or more accurately strives to one day encompass) every book ever written.

Does this mean that readers will be able to read books without buying them, thereby hurting the profits at the major publishing companies? Not at all. What it does mean is that people will have better access to the world’s books, and therefore will be more likely to find a work they want to read (and therefore, buy).

Fed Meeting & Dell’s Numbers

The recent rally has been long overdue. Going into tomorrow’s FOMC meeting, I would not be surprised to see a small rally into the decision, followed by a sell-off after the language of the statement shows no slowing of interest rate hikes on the horizon. So, if the Dow is up 30 or 40 in the morning, it might be a good idea to take some chips off the table for the afternoon.

That said, after seeing Dell’s surprise earnings warning tonight, a small rally tomorrow might be overly optimistic. Dell stock has been very weak lately, so a shortfall isn’t totally shocking, but disappointing for tech investors nonetheless. Although Peridot does not have a position in Dell right now, a move down to, or even below, $30 per share could be an attractive entry point based on the notion that a corporate upgrade cycle will start taking shape next year.

Why I’m Not Selling Google

It isn’t an easy decision by any means, but when people are paying you to make investment decisions for them, you have to step up and figure things out.

Peridot has had a decent sized long position in Google for many months now. What makes the decision even more complicated today is that I decided to put on a trade yesterday to play the GOOG earnings release. I bought the Dec 300 Puts and the Dec 320 calls, with the stock at $308. The logic was that GOOG would probably move drastically after the Q3 report, but the direction of such a move was hardly assured. Fortunately, we did get a huge move after the blow-out report that has some analysts pegging the company’s 12-month price target at $450 per share.

Even with Google shares up $40 today, I’m not selling. Of course, my first instinct was to sell, given that my strategy is to buy when others are selling and sell when others are buying. After all, the only reason Peridot is long GOOG now is because the crowd was selling immensely when the company’s IPO lock-up period expired early this year, presenting an opportunity for those who prefer go against the consensus view.

My rationale for not selling today isn’t very complicated. Yesterday the company was trading at 41x next year’s estimates, a level investors were willing to pay based on an assumption of how fast they thought Google could grow. Today we know that the company is growing at an even faster rate than we figured just 24 hours ago. However, now the stock trades at 40x 2006 earnings.

Google’s growth rate has gone up, and the stock’s valuation has gone down. In this particular case, I can’t justify selling the stock, despite today’s $40 gain.

The Google Numbers

Are pretty amazing. If you are wondering why the stock is up $29 in after-hours trading, consider the following. Google (GOOG) grew revenue 14% sequentially from Q2 to Q3. During the same period, Yahoo (YHOO) grew sales 6%. So, right now GOOG is growing more than twice as fast as YHOO. And yet when you look at today’s closing prices, GOOG is 41x 2006 EPS with YHOO trading at 47x. Another point to think about is Google grew 14% sequentially in the 3rd quarter (which equates to 69% annualized), which is seasonally the weakest quarter of the year.

Talks For AOL Partnership Heat Up

Reports indicate that talks between Time Warner (TWX) and several technology industry giants regarding an online partnership with America Online have heated up in recent days. Some are speculating that a deal could value the entire AOL division at $20 billion. So what does TWX stock do yesterday on this news? It drops 2%, which can be attributed in part to the news that Yahoo and Microsoft are linking accessibility to their instant message programs.

Time Warner itself is valued at slightly more than $80 billion, with the AOL subsidiary widely considered dead as far as online innovation is concerned. And yet, reports of a deal are indicating that AOL might be worth 25% of Time Warner’s total valuation. If true, TWX’s current share price hardly makes sense to me. At $17, TWX repreesnts a wonderful value in a market that has been, to borrow a Jim Cramer term, a “house of pain.” If investors are looking for good deals with limited downside, Time Warner shares looks like a solid bet.

How Long Until Wireless Net Access is Free?

Google (GOOG) has gotten a lot of press lately after it submitted a bid to help provide free wireless “Wi-Fi” Internet access to the city of San Francisco. Rather than debate what Google has in mind as far as its future business model, I’d prefer to think about who gets hurt with such a technological development, so perhaps investors can make some money on the short side of the market.

Personally, I think free wireless access to the Net is inevitable. Maybe it’s courtesy of Google, maybe not, but that’s not the point. Ten or fifteen years ago, computer users would have laughed at the idea of getting high-speed access to the Internet over cable lines or from satellites, as opposed to their traditional phone lines. In the new millennium though, dial-up is dying, broadband has become mainstream, and wireless is getting there.

Online access is a commodity service, so it makes sense that prices are set to come down over time. However, with companies like Google sitting on billions of dollars in cash, they do have the ability to drive that price all the way down to zero. Interestingly, there are still two publicly traded stocks that are pure plays on Internet access; Earthlink (ELNK) and United Online (UNTD).

Much like Blockbuster Video (BBI) and Movie Gallery (MOVI), the core business of these online service providers is faced with falling prices and constant industry change. Given that the potential is there that paying for Net access could become a thing of the past, just like movie rental storefronts, a combined market value north of $2 billion for these ISP companies looks attractive to potential short sellers.

The Future of AOL

Rumors are swirling about what Time Warner (TWX) will do with AOL. CEO Dick Parsons has stood firm that they want to keep AOL as part of the company and transition it to an advertising model from a subscription model, given that AOL’s more than 20 million members have been leaving, and will continue to do so for obvious reasons.

Today, with the Google (GOOG) secondary offering complete (and it went well by the way, with the stock trading above the $295 offering price) the market is trying to figure out which of the rumors could come to fruition. Will Google buy AOL? Will Microsoft (MSFT) buy at least a stake in it and combine AOL with MSN? Reports indicate that at the very least, all of these major online players have had discussions.

While I don’t really have any insights into what will happen, I can tell you that the media and Wall Street will almost certainly badmouth any company that partners with AOL. For years investors have basically ignored AOL as a long-term viable part of Time Warner. Analysts often say that Wall Street is valuing it at zero when trying to explain TWX’s stalled out stock price.

However, there are things to consider here. Not only would any type of deal benefit Time Warner, assuming investors are assigning no value to AOL right now, it might not be a bad deal for Google, Microsoft, or anyone else. For the first six months of 2005, AOL had revenue of $4.23 billion. Some may be surprised how profitable this business is for TWX. Adjusted operating income (before amortization and depreciation) was $1.09 billion. Clearly, AOL is worth something and that something is in the billions.

AOL has to change business models. Home users of the Internet no longer need AOL as their gateway. Advertising at AOL has an uphill battle as Google and Yahoo (YHOO) continue to gain market share. With the help of a leading Internet force, AOL could very well become even more valuable, and investors are already underestimating the value of Time Warner’s America Online unit today.

Google Shares Moving Sideways on Low Volume


Newly released Google Desktop Search 2 and its accompanying Sidebar really gives you some idea of where the company is heading. They want to take over your PC and dethrone Microsoft as the desktop monopoly. I haven’t seen software innovations like these before. It’s hard to not get excited about it, and not even just from an investor perspective, but instead simply as a computer user.

As for Google (GOOG) stock, the chart looks very bullish. After a huge move, the shares have been moving sideways on lower volume. Growth investors probably can feel comfortable about owning it down at these levels. The next 6 to 12 months should be very exciting for industry watchers everywhere.

VeriSign Shares Becoming Attractive


Shares of Internet service firm VeriSign (VRSN) have gotten crushed recently after a lackluster Q2 earnings report resulted in a broken chart. After breaking $25 per share, technical sellers have pounced. At $21 VRSN is only about $1 away from the next support level, and trades at 20 times 2005 estimates. The company should grow 15% annually for the next few years and holds $3 per share in cash and no debt. If VRSN can hold the $20 level, it looks like an attractive entry point.

Google Offering Signals Major Moves Ahead

Leave it to Google (GOOG) to get creative a year after its IPO. Today’s announcement of a $4 billion secondary will come with rampant speculation as to how the company will use the money. It’s true that Google has been hiring like crazy and expenses will likely grow faster than sales. Their cash flow can cover those expenses without selling more shares, so the more likely use for the proceeds will be larger scale acquisitions. It will be interesting to see if and who they buy, and how Wall Street reacts to the fit of such deals. The stock is down today on the news, which is expected when any company offers stock, and the P/E on 2006 estimates is about 38 times.