Google Goes to $325 with a small blip in internet advertising

Google could easily lose half of its market value without a real stock market crash - here is why.

Google has reported another outstanding quarter driven exclusively by enormous growth in online advertising. For the quarter, the company earned $3.91 a share on a pro forma basis, excluding certain costs -- beating Wall Street's $3.78-a-share estimate. Net revenue, excluding the fees Google pays search-ad partners, was $3.01 billion, breezing past the $2.94 billion. The numbers and the dramatic growth - it all looks bulletproof and all the analysts (including some who have written on the site) have made the argument that Google is cheap relative to its expected growth.

The expected growth is by no means certain. For all of Google's grumblings about entering new markets, it has yet to generate revenue from anything other than paid search. It will take many, many years before any of Google's new efforts produces a meaningful effect on the bottom line, no matter whom they purchase and no matter how many people they hire for these efforts. Plus, it is still uncertain which way Google is going with many of these efforts - i.e., most are still in their infancy at best.

Google's paid search revenue can easily level off. First, their ability to generate revenue from paid search is largely (although not entirely) tied to their remaining far and away the best search engine available. With IACI and Ask.com to everyone who has a garage in Palo Alto trying to debunk them of this position, it isn't too unreasonable to assume that someone will create a better search engine and get whatever money is necessary to publicize it. I sense that Google's engine is already failing. Just try to Google your own name - whereas the results previously related to only your substantive accomplishments, you will now find that they have been infiltrated by companies that you have never heard of trying to sell your credit information, your contact information, etc. to others.

Second, advertisers could easily reduce their online advertising expenditures or simply become more judicious and deliberate in how they spend online. Google AdSense is a bidding model where advertisers have been throwing money at keywords left-and-right for the last year. Some of the money that is being paid by advertisers to get certain keywords was bordering on ridiculous about 2 or 3 months ago. In fact, these bids seem to have already come down. Just ask anyone who publishes a website and does business with Google and they will tell you that they are making less (or a per click or CPM basis). Now, they could be making less because Google has unilaterally decided to lower their payments and increase their own margins, but I would tend to believe that Google is running something of an honest operation and that they are reducing these payments to publishers because their receipts from advertisers have come down.

One way that Google can easily prop up its online advertising business is to get into pornography, but outside of Orkut.com in Brazil, they are showing little initiative in this area.

So, I think that Google is very, very vulnerable to a big fall.

Before anyone asks me about Yahoo!, let me just say that I agree that it is even more overvalued relative to its growth prospects. Their search business has already fallen apart and, barring a recovery, that stock ultimately will go much, much lower.

Aron Livrone
Aron Livrone: Aron is a 2008 Wharton MBA with a consulting background prior to moving from Sweden to the US to begin his MBA.

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Comments

  • art

    October 21, 2007

    Very sobering. It does look as though everyone has jumped on without giving much thought to the downside.

  • cortez

    October 21, 2007

    Online advertising is expected to grow at a double digit rate over the next 5 years according to Jupiter and Forrester research. Google's dominance is not just about its technology - which is the best - but its brand which is known worldwide and has become a verb - "I'm going to Google it." It will be almost impossible for someone to knock it off. It has a deep war chest of cash which it can use to acquire any real competitor.

    The international market is a growth opportunity for Google. Orkut already dominated in Brazil and India. The rest of the world awaits.

    I think Google stock will probably double or triple over the next 5 years.

  • Jeremy Artish

    October 21, 2007

    Don't you realize that you are describing the most perfect racket of all time? Google can essentially pay its suppliers what it wants (or cut them off) and charge purchasers the greatest amount that they are willing to pay on their indifference curve without ever proving definitively that the advertisement was delivered. If their revenues ever fall, they just increase their margins by cutting payments to web publishers. This is a "pick your margin" business. While the two risks that you cite are real, but you are overstating them. For now, it is just one helluva business.

  • Ken Rosenfeld

    October 21, 2007

    It is at $650 and it goes to $325 with a 2-for-1 split in the next week or a 3-for-1 split in about a year. I suggest that you cover your short and take your losses.

  • Jon Robertson

    October 21, 2007

    I own a small business in California, and I've been cutting back on my Yellow Page advertising. Now I see that the Yellow Pages has now been sold off by the phone company to Arc Media or something. Which means to me that it's revenue is falling fast due to people like myself, unwilling to pay them the amount of money they want.

    And so how do I advertise? The web and with direct mail. Google is taking over the Yellow Pages business. Figure that into your scenario and see what comes up. I myself have owned a part of Google since $98, and I'm not looking back. If it drops significantly, fine, I'll just buy more, just as I've done with Apple, which is in the process of replacing Dell and IBM.

  • shraz

    October 21, 2007

    When are they gonna split? It's crazy to eliminate the poor people who don't have 10K in their brokerage.

  • jlmadara

    October 23, 2007

    goog is a piece of shit

  • GOOG to 325

    October 23, 2007

    I agree GOOG is overlimit. The bottom line is, any higher, GOOG surpasses MSFT in cap. This just be done given what they do. Too young, too much, too fast. It's not googlish, its GOOGARBAGE. GOOG is simple, and really, should be a free site to all. What a rip off. It will fade and come to earth. Remember AOL. Heck, even Turner thought it was the real deal. Now, AOL can't give their service away. All I'm saying is that GOOG is not worth 200 Billion. Maybe 50 Billion, but not 200....

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