John Hussman on Google

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.”

Google vs Time Warner

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.

Google Prints $300

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.

Google Mulls New Online Payment System

A reader first postulated this idea to me on this site a while back. What if Google (GOOG) came out with its own online payment system to rival PayPal? Given eBay’s lack of success in trying to topple the market leader years back (eBay created Billpay, only to later fold it and purchase PayPal for $1.3 billion three years ago), I was doubtful as to the merits of such a strategy and how it fit in with Google’s overall focus on search applications.

However, The Wall Street Journal is reporting that Google plans to launch its own online payment system later this year. I still believe, given PayPal’s overwhelming lead and seemless integration with eBay, it will be difficult for Google to make significant inroads in the business. But you still have to think about the possible ramifications.

There is one way Google could really put the heat on PayPal, in my opinion. As eBay has seen its domestic listing growth slow, they have responded by raising prices both on their auctions and for online payments. This has infuriated many sellers and caused them to look elsewhere in many cases. In fact, eBay saw month-over-month declines in total listings earlier this year, which many attribute to their fee hikes.

If Google decided to meaningfully undercut PayPal on price (PayPal currently takes 2.9% of debit and credit card payments received, plus a transaction fee), eBay would have to react with price cuts of its own, or risk losing meaningful market share. How vulnerable is eBay to such an event? Well, in the first quarter of 2005 PayPal accounted for 23% of eBay’s revenue.

As a Google shareholder, I am hoping they can make a dent in eBay’s business. If they can, eBay’s stock, which currently fetches 38 times 2006 earnings, may be ripe for selling. For 42 times 2006 earnings investors can own GOOG shares instead, and enjoy a higher growth rate, more EPS upside surprise potential, and fewer competitive pressures.

Apple/Intel Deal: Too Much Hype

The buzz today was focused on the confirmation of previous reports that Apple (AAPL) will begin using Intel (INTC) chips in its computers, after years of an exclusive partnership with IBM (IBM). In addition to IBM, former Motorola subsidiary Freescale (FSL) is also seen as a loser in this deal, as they manufacture those chips for use in Apple products.

While this shift is interesting, and certainly reiterates the notion that IBM has been long extincted as far as technology bellwethers go, the investment impact should be downplayed in my opinion. Nothing about this change is going to meaningfully boost, or hurt, corporate profits for any of the major players.

Apple isn’t going to sell more computers simply because they sport “Intel Inside.” Additionally, Apple only accounts for 2 or 3 percent of total business for IBM and Freescale. Intel has been deemed the “biggest” winner of all, but Apple only has a little more than 3% of the world market for personal computers.

All in all, anything more than a slight move in the share prices of these companies, based on the Apple/Intel partnership, should be seen more as hype than substance.

Sun Micro-StorageTek Merger Warrants Mixed Reviews

Once a high tech high flier, now-struggling hardware maker Sun Microsystems (SUNW) hopes its planned $4.1 billion acquisition of StorageTek (STK) will help boost its languishing $3+ stock price. We can judge this deal two ways, from a financial perspective and from a strategic perspective.

First, the finances. Sun will pay $4.1 billion in cash ($37 per share) for STK, which has over $2 billion in annual sales. Sun has a war chest of more than $7 billion in cash, so an all-cash deal makes sense since they have the financial flexibility to avoid diluting existing shareholders. Even better, though, is the fact the StorageTek has $1 billion in cash of its own, so the actual price of the acquisition of the storage business itself is more like $3.1 billion, which equates to about 16 times trailing twelve month net income. All in all, Sun got a good deal.

However, money isn’t everything. Since Sun Micro currently is 5 times the size of STK, StorageTek’s net income will only add about 6 cents to Sun’s annual EPS. The reason why its share price is under $4, though, is because the company isn’t making money on its $11 billion in annual revenue. Until Sun can boost margins and turn its main business profitable, investors will have a very hard time justifying bidding up the stock. The cash cushion was providing a floor with a lack of profits, but that cash has been decreased significantly.

Most Ridiculous Item of the Day

Mark Klee, a technology fund manager, on why he doesn’t own shares of Google:

“We don’t own Google. The valuation is just too high for us. We do own Yahoo, though, Google’s main competitor.”

So Google stock is too expensive, but he owns Yahoo. As a mutual fund manager, you would think Klee would understand how silly this view sounds to anyone who follows these two companies. Google trades at 50x 2005 earnings and 39x 2006 profit expectations. Yahoo’s ’05 and ’06 multiples are 65x and 51x, respectively.

I’d love to know why Yahoo is cheap enough for him to own, but Google’s valuation is too high, especially when Google is growing faster. As far as GOOG’s $14 jump today, to an all-time high of $255 a share, I still think the stock has more room to run. I would not be surprised to see $300 by year-end, at which point I will most likely take some money off the table.

InfoSpace Authorizes $100 Million Buyback

Evidently the board of InfoSpace (INSP) sees the same type of value in its stock that I do. The company has announced it will buyback up to $100 million of its shares in the open market. With a $1 billion market value, this represents 10% of the company’s outstanding shares. Quite meaningful if you ask me.

Although I have noticed the magnificent balance sheet InfoSpace possesses, the stock’s pre-buyback announcement price of $29 a share shows that many investors clearly have not. By buying back stock and increasing the company’s earnings, Wall Street hopefully will see how undervalued the shares really are.

With $384 million in cash and no debt on InfoSpace’s balance sheet as of March 31st, shareholders need not worry that the $100 million investment will hurt the company’s ability to grow. At $30 per share, the stock remains dirt cheap and a very attractive acquisition candidate. A buyout at 20x earnings, net of cash, would amount to $48 for each INSP share.

Pending Mergers Could Provide A Catalyst For Google Shares

As Google (GOOG) brushes up against it’s all-time high of just under $230 a share this morning, investors should avoid taking profits just yet. The next catalyst for Google, which could send it to $250, might be its addition to the S&P 500 index.

It’s difficult to know for sure when the company will be added, but there are 4 reasons to believe it will be sooner rather than later. Google’s sheer size (not to mention its performance) makes it a prime candidate to be one of the next technology-related companies added to the benchmark index. There are currently 4 pending mergers that should close in the next 6 months, with several possible in the next couple of months.

AT&T (T), Nextel (NXTL), Sungard Data (SDS), and Veritas (VRTS) are all current S&P 500 components and are set to be bought out shortly. Google would be a logical fit to replace one of them, most likely Sungard or Veritas. Such an announcement could very well give the shares another boost before the company reports their Q2 earnings in July.

Regardless of when the S&P 500 addition occurs, the stock should gain ground on the news given how many shares various index funds would have to purchase, based on Google’s current market cap of $63 billion.

Other news:

The stock’s price action certainly seems to indicate that Delta (DAL) will be the next Chapter 11 casualty in the airline industry. The shares have plummeted from $3.50 to $2.50 since yesterday’s earnings warning. They continue to have NO oil price hedges in place for the remainder of the year and beyond. Brilliant.

Great Quarter for Yahoo!

So much for the soft pricing on online advertising that RBC Capital Markets analyst Jordan Rohan cited in his negative comments toward Yahoo (YHOO) and Google (GOOG). Yahoo’s quarter came in meaningfully ahead of expectations, with EPS at 13 cents and revenue at $821 million, versus analyst estimates of 11 cents and $797 million.

The stocks of the online search and advertising companies are reacting very positively in after-hours trading. YHOO is up more than $2, with GOOG up $12, and INSP rallying 3% after a 4% gain during the regular session. No doubt that the shorts will be forced to cover before the latter two companies report their Q1 numbers.

Both Google and InfoSpace appear to be cheaper than Yahoo, so I’d stick with those two names in this sector.