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.
Via the link below you will find archives of two conference calls held this month by Overstock.com (OSTK) along with a slideshow to go along with each. I suggest listening to the Q2 call first, then the one about the lawsuit, in order to get a full understanding of what’s going on. Entertaining is an understatement. They will also help you understand why 52% of OSTK’s float was sold short as of July 12th, and you can’t borrow any shares as of today.
Nokia (NOK) shares are up this morning as rumors are swirling that Cisco Systems (CSCO) might target them as an acquisition target in the wireless space. Before investors get too excited about the possible combination, let’s recall Cisco’s acquisition strategy.
The company does a lot of deals, but very small ones in most cases. The idea that Cisco would be interested in a mega-deal seems farfetched to me, and probably mentioned mostly for headlines. Cisco has a done a few medium size deals (The 1996 purchase of Stratacom for about $4 billion comes to mind), but CEO John Chambers paying $73 billion for Nokia would be surprising, given that Cisco is only worth $124 billion, hardly a small deal to swallow.
Now I know this is the largest search site in China, and only 10% of that country is online today, and people are making a Google (GOOG) comparison, but keep in mind the company is now worth more than $4.3 billion and had first quarter sales of $5.1 million.
If you have some shares of Amazon.com (AMZN) I can’t help but suggest you at least consider selling some up here at $46 per share. The stock is up 20% since the company’s solid second quarter earnings report.
Now I know Amazon was supposed to be a superior retailing operation because of its online model, but if you compare it to Barnes and Noble (BKS), they’re pretty similar. It’s true that BKS isn’t going to grow 15% annually long-term, but a 2006 P/E of 48x for Amazon seems too rich to me. After all, that’s 3 times its expected growth rate!
As for the thesis of higher profit margins associated with a lack of bricks and mortar stores, Amazon’s 2004 operating margins of 6% barely nudge out Barnes and Noble’s 5% margin. Turns out that gigantic warehouses across the country cost about the same as actual storefronts.
For those who feel Google (GOOG) shares are expensive at 40x next year’s profits, Amazon stock must look even more overvalued, given it trades at 48x forward earnings and is expected to grow its business 18% next year, versus 45% for Google.
Earlier this week I postulated Google (GOOG) would report Q2 EPS of $1.35. Sure enough, tonight the company reported $1.19 in EPS including $0.16 in options expensing, which took the number up to my target. The stock is tanking after-hours as investors are always looking for more than most growth companies can deliver. Shares are down 6 percent or $18 to $296 each.
It will be interesting to see what the always valuable (read with sarcasm) Wall Street analysts say in the morning, especially after Google management warned on the call that Q3 is a seasonally weaker quarter (which we all know already). I have little doubt we will continue to see immense selling tomorrow morning, but I would expect money managers who still like the story to bargain hunt under $300 and help the stock recover some lost ground by the afternoon.
I still believe the stock will ultimately trade to 50x EPS, or $350 a share, in the next 6-9 months and as a result would not recommend panic selling alongside everyone else right now with the stock sub-$300. Google still deserves at least the same multiple as Yahoo! (YHOO) and eBay (EBAY) if not more.
Shares of Yahoo! (YHOO) are getting slammed after the company met earnings numbers for Q2 but fell short in revenue both for the most recent quarter as well as full year 2005 guidance. Given that YHOO was trading at 65 times 2005 numbers before the report, making the stock priced for perfection, such a collapse isn’t surprising and shows us what happens when the market’s most expensive stocks don’t knock the cover off the ball.
On to Google (GOOG). Google is weak also as investors surmise that Yahoo’s shortfall could hamper Google’s ability to beat estimates when it reports on Thursday. While this is entirely possible, I would not be surprised at all to see Google beat bottom line numbers. Why? Well, YHOO reported 13 cents for Q2, same as the prior quarter. Google reported $1.29 per share in Q1, but the estimate for Q2 is only $1.20 per share.
Google’s higher growth rate, compared with Yahoo, also might allow it to show sequential growth in EPS for Q2. The highest estimate on the Street is $1.34. I think GOOG could very well report $1.35+ on Thursday, despite the weak YHOO report. Maybe they are taking share from Yahoo.
Would that even be enough to boost the stock price meaningfully? Maybe, maybe not, but I would rather be long Google than Yahoo and I doubt we’ll see as much disappointment in the GOOG report as we have with YHOO. Hopefully we can see GOOG maintain the $310 level throughout the week. Given what we know right now, that might be a better case scenario than we thought as early as this morning when people were positioning for a Yahoo beat.
An interesting take on Google’s current valuation and possible future returns from the manager of the Hussman Strategic Growth fund:
“Let’s assume that Google is in fact, the next General Electric, Microsoft and Cisco Systems; that investors buying the stock here are, in fact, getting in on the ground floor. What sort of return can those investors expect over the long-term?
Let’s see. OK, we know that total global advertising (television, radio, magazines, newspapers, billboards, and so forth) represents about $350 billion at present, and is projected to grow about as fast as the global economy in the future, about 6.5% annually, according to PriceWaterhouse Coopers. Total internet advertising is currently about 6% of that total, but let’s project that 15 years from now, the internet share booms to 20% of all global advertising. Let’s also assume that Google gets 75% of it.
That puts Google’s revenues 15 years from now at $135 billion a year, which is close to those of GE. Let’s also assume that stock market valuations remain at a permanently high plateau, and that Google gets awarded the same rich price/revenue ratio of 2.4 that the market awards to GE, which again, is the most generous price/revenue ratio awarded to any stock with revenues over $100 billion.
We now have everything we need to calculate the expected return to investors:
Price_future / Price_today = (Rev_future / Rev_today) x (P/Rev_future / P/Rev_today)
= ($135 billion / $3.8 billion) x (2.4 / 20.5) = 4.159
which implies an annual return on Google of 9.97% annually.
What if Google is the next Microsoft and Cisco Systems? Well, MSFT has about $38.9 billion in revenues, and CSCO about $24.2 billion. So $31.6 billion on average, with an average price/revenue multiple of 6.0. Let’s assume that Google gets there in just 10 years.
Do the math:
($31.6 /$3.8) x (6.0 / 20.5) = 2.434
which implies an annual return of 9.30% annually.
Suffice it to say that even taking as given that Google is, in fact, the next GE, Microsoft and Cisco Systems, investors buying the stock at its current price aren’t in for big returns.”
It seems CNBC has fallen in love with a market value comparison between Google (GOOG) and Time Warner (TWX). Their anchors are asking every single person they can find how one can justify GOOG being valued at $86 billion while TWX sports an $80 billion market cap. The way they have been wording it makes it seem like any sane human being should think that statistic is completely insane. After all, TWX will have $44 billion in annual sales this year, whereas Google will book less than $4 billion in revenue.
Let’s break this comparison down to see how silly it is. Since when are stocks valued based on their sales? Healthcare services firm Express Scripts (ESRX) is worth $3.7 billion with expected sales in 2005 to hit $16 billion. Another healthcare company, Lincare Holdings (LNCR) is going to book $1.2 billion in revenue this year but it’s worth $4.3 billion. ESRX has 13 times as much revenue, but is worth 15% less in the market. Are these two companies being misvalued on Wall Street too?
The formula for a stock’s price is pretty simple:
Stock Price = (Earnings per Share) x (Price/Earnings Multiple)
Nowhere in this formula will you find anything about sales. Companies are valued on their earnings. That’s one half of the equation. The other half is the multiple. The multiples investors are willing to pay are determined by growth potential. More growth… higher P/E, and vice versa.
Now let’s take a look at Google and Time Warner again. Time Warner has billions in debt. Google doesn’t. Time Warner’s enterprise value of $93 billion is far greater than its market cap of $80 billion. Google, on the other hand, has a ton of cash giving it an enterpise value of $82 billion, or $11 billion less than TWX.
Now let’s look at earnings. It’s true that Google’s 2006 P/E is 46x whereas Time Warner’s is 19x. If we use enterprise value instead of market cap, we get 44x for GOOG versus 22x for TWX. How can we justify a P/E for Google twice that of Time Warner? Well, in 2006 Google is expected to grow its business by 41%. Time Warner’s growth? A paltry 5%.
The question investors are asking themselves is this. Would I rather pay 44x for 41% growth or 22x for 5% growth? The answer has been obvious, as Google shares have soared from $85 to $308 since August. Conversely, Time Warner stock has been dead money. Interestingly, I think TWX is a very attractive investment down here at $16 per share.
After a run earlier this month failed at $299 and change, Google shares finally hit $300 today, closing at $304 per share. This level has been the one I’ve been waiting for to lighten up on my Google position. While I am still bullish on the company, I think it is careless to not cash in a little bit of stock.
The $300 level equates to 45 times 2006 earnings estimates. This multiple seems fair given Google’s growth prospects and the ability of the current consensus EPS number to move over $7 as 2005 plays out. That said, it is a very high multiple. Only companies that are in a truly unique position are going to fetch such a price.
I continue to want exposure to the name in coming months. However, the time has come to ring the register. As a value-oriented guy, Google shares no longer present the “value” they did at $170 each. That said, I do not think they are overvalued given what we know today. If we get to 50x forward earnings, it might be time to sell off another chunk of stock.
It should be interesting to see how the future plays out, or more specifically, how high earnings projections can go. That will determine how long this rally continues.