Internet-related - Google Inc. (GOOG)
Published by TedMurphy on June 13, 2008

Google (GOOG) - The Internet Leader For the Foreseeable Future
Recommendation: Buy at $550 or below (current price $550)

Internet-related is the Biggest and Fastest Growing VC Sector

Internet-related venture capital investments have attracted 21.5% of the money and 25.6% of the deals I’ve tracked over the last six months, making Internet-related the largest and fastest growing sector for venture capital. That’s up from the 14.0% and 19.6% of the money invested and deals done in this sector during the first six months of 2007.

You can track the ongoing popularity of the Internet-related sector — and 8 other sectors — by using the VCA Themes sector screening page.

You can also track the internet companies here on VCA Stocks, and it is obvious that Google is much, much larger than other pure play internet companies. With a market capitalization of $175 billion, Google is more than half again larger than the combined market capitalization of Ebay, Amazon, Yahoo, Expedia and Priceline.

Google’s outsized success is due to its dominance of search.

Search is a Special and Valuable Application

Search page views are rare and valuable. They comprise perhaps 1% of the internet’s page view inventory, yet they generate over 40% of the revenues. Search page views are diamonds in the rough, gold nuggets in a stream of gravel, a needle in a haystack, etc.

It took both internet advertisers and publishers a while to figure this out, as you can see in the table below. In the year 2000, “keyword search” was 1% of all US internet advertising revenues. By 2007, the category had grown to 42% of all revenues. During the same seven year period, display advertising had almost no growth in revenues and saw its market share dwindle from 82% to 33%.

Those numbers are for the US, but search is a global phenomenon — and we see the same 42% market share abroad. In an extremely interesting investor presentation filed by Yahoo with the SEC in March of 2008, Yahoo projects that the global online advertising market will grow from $43 billion in 2007 to $78 billion in 2010. Market share for Search revenues are projected to remain stable over that period, going from $34 billion (42% of $43 billion) in 2007 to $44 billion (44% of $78 billion) in 2010.

In the same report, Yahoo reveals their internal estimates for CPMs on Search versus various Display advertising types. Yahoo expects their Search page views to deliver a CPM of $40, while their Display page views deliver a range of value depending upon the type of advertisement — from $0.50 for Non-Premium Graphical to $25 for Online Video advertisements. As an aside, Classifieds page view CPMs are even bigger than Search, with Yahoo estimating a CPM of $50 for Classifieds.

I think the real blended CPM rate for page views other than Search (or Classified) is around $0.55. I get this by taking the ratio of Display to Search advertising revenues (58% / 42% = 1.38), dividing by the ratio of Display to Search page views (estimated at 100 / 1), then multiplying by the Search CPM of $40. So, 1.38 / 100 * 40 = $0.55.

My website here did a CPM of $0.86 over the last three months using Google adsense, and Google is almost certainly overpaying me — my clickthrough rate is only 0.11%.

The value in a Search page view (and it appears a Classified page view) is that a Search is closely connected to an ecommerce transaction. This is exactly where an advertiser wants to be situated. Accordingly, the Internet eco-system has determined that a Search page view is worth over 70 times as much as a non-Search page view ($40 cpm vs $0.55 cpm).

How Far Can Google Go?

Analysts have some very aggressive expectations for Google, with revenues projected to rise from $11.7 billion in 2007 to $20.6 billion in 2009. Earnings are expected to rise less quickly, from earnings per share of $15.57 in 2007 to $24.69 in 2009. These figures imply conservative margin assumptions from analysts, in that they are expecting Google’s income to grow less rapidly than revenues. Still, those revenue assumptions are breathtaking. How can we expect a company this large to grow so quickly?

Looking out 5.5 years to 2013 compounds the problem, in that Google’s revenue numbers seem to expand absurdly. A 17% growth rate in revenues from 2009 to 2013 grows already aggressive consensus revenues for 2009 of $20.6 billion to $38.5 billion in 2013. Is that $38.5 billion an impossible stretch?

It turns out that $38.5 billion in 2013 is not an impossible revenue number for Google. Here’s how it can be accomplished.

If internet advertising revenues in the US grow as much over the next 5.5 years as they did in the last three years (on a dollar basis, not a percentage basis), we would see $32.7 billion in internet advertising revenues in the US during 2013. As the table below shows, that would be about 18% of the total US advertising market — less than half the money spent on TV advertising and about the same amount as spent on either newspapers or magazines. This is not an unreasonable 5 year forecast for US internet advertising revenues.

Google’s US revenues in 2007 were $8.7 billion, 41% of the total internet advertising revenues last year. Google’s portion of the US internet advertising market has been rising rapidly, so I feel comfortable assuming a 45% market share for Google by the year 2013. This gives Google a US revenue projection of $14.7 billion by 2013.

The US was estimated to be 40% of the global advertising market in 2007, and that ratio is expected to drop to 37% by 2010. Advertising growth is of course greater abroad (all growth seems to be greater abroad these days). Google produced 51% of its revenues abroad in the first quarter of 2008 — if we project that ratio to reach 63% by 2013, in line with the global marketplace, we arrive at an international revenue projection of $25.5 billion for Google in 2013.

This gives us a combined revenue projection for Google of $40.3 billion by 2013, higher than the $38.5 billion projected through a combination of consensus revenue estimates followed by 17% annualized growth.

Valuing Google at $550 Now, $933 Long Term

View the spreadsheet used for this valuation analysis.

You can click the spreadsheet above to see the details, but basically I have developed a December, 2013 target price for Google of $933. The stock is trading for $550 right now, which would imply a 10.0% annualized return over the next five years. This 10% annualized return is what I require to buy Google, so the stock is a buy for me here at $550.

I’ve made several assumptions in developing this five year target value of $933.

Downside to $430

I am tempted to hold off buying until Google reaches back down to the $430 level of mid-March. That would give me a 15% annualized upside.

The June quarter has historically been Google’s weakest operating quarter, and summer time is usually good for a technology pullback. Google has pulled back at some point in the July-August time frame in both of the last two years.

I am tempted, but that is not my call here. I would buy Google at $550 or below, right now.

US Internet Advertising Revenues

These internet advertising figures are pulled from the Interactive Advertising Bureau’s press releases over the last seven years.

US Online Advertising Revenues - $ Million
2007 2006 2005 2004 2003 2002 2001 2000
Keyword Search 8,805 6,799 5,142 3,850 2,543 900 288 82
Display Advertising 4,455 3,685 2,508 1,829 1,526 1,740 2,592 3,936
Sponsorship 636 496 627 770 727 1,080 1,872 2,296
Rich Media 1,981 1,192 1,004 963 727 600 360 492
All Display 7,072 5,373 4,139 3,562 2,980 3,420 4,824 6,724
Classifieds 3,321 3,059 2,132 1,733 1,235 900 1,152 574
E-mail 424 338 251 96 218 240 216 246
Slotting Fees 0 0 125 193 218 480 576 246
Lead Generation 1,584 1,310 753 193 73 60 144 328
Total Internet Advertising 21,206 16,879 12,542 9,627 7,267 6,000 7,200 8,200
% of US Online Advertising Revenues
2007 2006 2005 2004 2003 2002 2001 2000
Keyword Search 42 40 41 40 35 15 4 1
Display Advertising 21 22 20 19 21 29 36 48
Sponsorship 3 3 5 8 10 18 26 28
Rich Media 9 7 8 10 10 10 5 6
All Display 33 32 33 37 41 57 67 82
Classifieds 16 18 17 18 17 15 16 7
E-mail 2 2 2 1 3 4 3 3
Slotting Fees 0 0 1 2 3 8 8 2
Lead Generation 7 8 6 2 1 1 2 4
Total Internet Advertising 100 100 100 100 100 100 100 100
Y-Y % Growth in US Online Advertising Revenues
2007 2006 2005 2004 2003 2002 2001 2000
Keyword Search 30 32 34 51 183 213 251 na
Display Advertising 21 47 37 20 -12 -33 -34 na
Sponsorship 28 -21 -19 6 -33 -42 -18 na
Rich Media 66 19 4 32 21 67 -27 na
All Display 32 30 16 20 -13 -29 -28 na
Classifieds 9 43 23 40 37 -22 101 na
E-mail 25 35 161 -56 -9 11 -12 na
Slotting Fees na na -35 -11 -55 -17 134 na
Lead Generation 21 74 290 164 22 -58 -56 na
Total Internet Advertising 26 35 30 32 21 -17 -12 na

Total US Advertising Revenues - TV, Radio, Print and Internet

Non-Internet advertising figures shown below are gathered from TNS Media Intelligence press releases. The US Internet figures are (as in the table above) pulled from the Interactive Advertising Bureau’s press releases.

Total US Advertising Revenues - $ Million
2007 2006 2005 2004 2003 2002 2001
Television Media 64,421 65,552 62,103 61,838 55,471 52,666 48,091
Magazine Media 30,328 28,743 28,739 26,347 25,981 26,056 26,044
Newspaper Media 26,363 27,919 28,646 28,118 26,072 22,906 21,377
Radio Media 10,692 11,085 11,018 10,918 10,886 9,993 8,061
Internet 21,206 16,879 12,542 9,627 7,267 6,000 7,200
Outdoor 4,020 3,831 3,529 3,213 2,674 2,475 2,456
Total Advertising 157,029 154,008 146,576 130.061 128,351 120,097 113,229
% of Total US Advertising Revenues
2007 2006 2005 2004 2003 2002 2001
Television Media 41 43 42 44 43 44 42
Magazine Media 19 19 20 19 20 22 23
Newspaper Media 17 18 20 20 20 19 19
Radio Media 7 7 8 8 9 8 7
Internet 14 11 9 7 6 5 6
Outdoor 3 2 2 2 2 2 2
Total Advertising 100 100 100 100 100 100 100
Y-Y % Growth in Total US Advertising Revenues
2007 2006 2005 2004 2003 2002 2001
Television Media -1.7 5.6 0.4 11.5 5.3 9.5 na
Magazine Media 5.5 0.0 9.1 1.4 -0.3 0.0 na
Newspaper Media -5.6 -2.5 1.9 7.8 13.8 7.2 na
Radio Media -3.5 0.6 0.9 0.3 8.9 24.0 na
Internet 25.6 34.6 30.3 32.5 21.1 -16.7 na
Outdoor 4.9 8.6 9.8 20.1 8.0 0.8 na
Total Advertising 1.9 5.0 4.5 8.9 6.8 6.2 na

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