Investment Review of Google

As part of my course I had to write a report about a company involved in e-business, I chose Google. There is a background briefing about the Google and then my thoughts as to whether you should invest in them, I found this very interesting - April 2008

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Google Incorporation: Background Briefing

What is Google?

At the basic level Google is a search engine, a tool for finding information on the World Wide Web, but really it’s much more than that, some might call it a web portal, but in recent years Google has gone beyond even what would traditionally be considered a web portal. Yes, you can search for a variety of different things, you can find news feeds, check your email, the classic things that you’d expect from a web portal. But more than that, you have a calendar, you can blog, you can share photo albums, you can create documents, search through books, you can pay for business services, you can buy technology. If Google can still be called a web portal, it has certainly redefined, and substantially raised the bar for what it means to be a web portal, it truly is in a class of its own.[1]

Where did it come from?

The Google Incorporation was founded in 1998 by two Stanford, Computer Science graduates, Sergey Brin and Larry Page. Page says that “The perfect search engine, would understand exactly what you mean and give back exactly what you want.”[2] That’s the basic vision of what Google is about, it set out to be the ‘perfect search engine’ and to be the world leader in search technology. As stated in the first section, Google is a lot more than just a search engine, but initially it set out the be the best at one thing, at searching for web pages, and it achieved that aim. The more advanced features of Google have flowed from the fact that Google is the world leader in search engine technology, and as such provides the perfect base to launch web services such as Gmail, Picasa photo albums and Calendar.

How do they make money?

Most Google services are free, so how do they make such large sums of money? Point six of Google’s philosophy is to say “You can make money without doing evil”,² which makes the question even harder to answer, most services are free, and they’re not doing anything dodgy, so how have they become so successful?

Adwords

The big earner for a search engine is advertising. Traditionally this meant banner ads and pop-up windows, but users don’t like these, and they’re not hugely effective because they’re not directed to a specific audience. As Google became more popular it was able to sell search link space in their search results, or ‘Sponsored Links’. In many ways these are not adverts, because they appear based on your search terms, however many businesses will pay lots of money for their website to appear at the top of a user’s search results.

In 2006 a survey conducted by Google revealed that on average people now spend more time surfing the Internet than watching television,[3] which by implication would suggest that the Internet is now the key place for businesses to advertise, with a massive audience and the ability to target adverts to specific audience groups much more easily, it is an advertisers dream. Adwords is popular for businesses for another reason too, unlike a TV or newspaper advert where you will pay a flat rate to advertise, not knowing necessarily who is seeing it and how effective it has been, the Adwords program will only charge a business based on whether a user selects their link. So effectively a business only pays for the adverts that work, which causes a user to visit the page.

Checkout

E-commerce is a normal part of life these days, whether we’re buying in online auctions, doing the weekly shop, or getting cheap books online, we’re all buying and selling over the Internet a lot more. Large e-commerce websites will have their own customised payment systems that are part of wider sales and stock systems, but smaller businesses often use third-party payment processors such as; Paypal or Worldpay, who take a small percentage of the value of each transaction that they process. Paypal has always been the leader in this sector, partly due to its partnership with Ebay, but Google Checkout has much potential to challenge these established businesses in this sector, because it has a good reputation of getting the job done. Ebuyer, one of the leading online computer retailers has recently added Google checkout as a payment method for its shop, so even established online shops are opting to use Google’s technology.

Selling Technology

There’s no value in reinventing the wheel, so if a business needs to implement search technology on its website, or company intranet, then the sensible move is to contact Google, as the world leader in search technology, they will be able to provide a search solution to meet the needs of virtually anyone. Google’s technology is valuable because it is so good, but it becomes even more valuable when you realise just how many different organisations can make use of it and are potential B2B customers for Google.

How successful is Google?

Google went public in August 2004, selling around 20 million shares at $85 each, raising $1.67 billion, valuing Google at around $23 billion.[4] Ironically, Google’s main rival, Yahoo! has benefited greatly from the continued success of Google. They were given 2.7 million shares in Google as settlement for a patent infringement case, and the rights to purchase more, Yahoo! now owns over 8 million shares in Google.[5]

At the start of the new millennium, Yahoo’s share price had its peak at just over $100, Google on the other hand peaked in November 2007 at $741 per share, and has a market value of over $170 billion. Google has grown 7-fold in just 3½ years of public trading, filling the gap left by Yahoo’s decline. These figures were taken from Google’s financial information website, just showing how pervasive Google’s services are on the web.[6]

Google as a Trademark

Google is currently ranked at the 20^th most valuable brand name in the world.[7] It is estimated that the Google brand is worth over $17 billion, a massive increase in value of 44% over the same value 12 months earlier. This makes the Google brand more valuable than the likes of established, global brands including Sony, Nike and Ford, and it is worth $10 billion more than Yahoo!, its closest rival in its field.

It’s hard to believe that a web portal, which is not a tangible thing, can become such a successful brand. However, as the World Wide Web has become an indispensable part of modern life, so Google has become the essential tool to search the WWW. In the late 90’s and early years of the new millennium, there were a plethora of web portals generally offering much the same services, with little to choose between them, with Yahoo! being the leader in the field. Altavista, Dogpile, Ask Jeeves are all still around, but who actually uses them? There was a time when these would have been a viable alternative, even on a par with Google. But these are all just search engines, unlike Google and Yahoo! who define what is to be a web portal.

You only need open the dictionary to see how Google has become an essential tool in modern life. The entry in the Miriam-Webster dictionary for ‘google’[8] is not a noun, a number with one million 0’s at the end (although in fact that would be a misspelling of ‘googol’), the word from which Google derives it’s brand name. Instead, ‘google’ is a verb, ‘to google’, “to use the Google search engine to obtain information about (as a person) on the World Wide Web”. A whole new dictionary entry has been created to describe the way in which we use the World Wide Web, not a general term, but a term specific to a particular company, a single search engine.

My own personal website proves the dominance of Google in the search engine market, in January 2008, I received 90 website accesses via search engine results. 88% of these accesses came from Google, with 11% from Yahoo and 1% from AOL.

Pioneering Web 2.0

A successful business will be a leader in its field, taking the initiative in pioneering new technologies which result in better processes for getting the job done. Google started this work by producing the best search engine technology on the market, that is how they came to be such a success, but now they are expanding into new areas of web services and embracing new technologies, such as Web 2.0, in order to make these services work well. Web 2.0 is one of those so-called ‘buzzwords’ that do the rounds every so often in the technical world, it’s a word that sounds cool and innovative, and it’s vague enough for executives to slip it into presentations, to let the audience know that they’re at the cutting edge.

Web 2.0 is notoriously vague, it is in many ways indefinable, but simply it is just speaking of a new way of doing things. It’s about making the most of the Internet, about giving the user a good experience, designing from a user-centric point of view. It’s about embracing the latest technologies and making them work together; XML, CSS, AJAX and RSS. It’s about having dynamic content, it’s about user contributed content, it’s about knowing where to implement server-side and client-side technology, and getting them to work together. It’s many things, but without doubt Google is a pioneer in this field.

Where next?

Google is here to stay that’s in no doubt, and it is already revealing it’s dominance in the web services market, showing their strength in recent years with the acquisitions of Youtube, FeedBurner and Blogger. Google has also showed its power in the controversy with privacy legislation and it’s refusal to hand over search records to national security agencies. We shall talk about the future of Google, and the potential for investment in more detail in a later discussion, but suffice to say, to be where Google is now, less than 10 years after its formation, is testament to Google’s success and positive looking future.

Google Incorporation: Investment Recommendation

In our initial discussion of the search engine market, we were left somewhat staggered by the growth of Google and its dominance in this market, which it has achieved in under 10 years. It should therefore not come as any surprise that in this rapidly evolving industry there is much to talk about since the initial discussion.

‘Dominant and Stagnant’

Google remains dominant in the search engine market, in February 2008 it increased its share of the US search market to 58.7% with Yahoo losing out.[9] Google’s grip of the market is even greater across the rest of the world, the latest figures for 2008 reveal that Google had 89.6% of the German market, 89.9% of the French, and in the UK 66.4%, dwarfing all of the competitors.[10] However, despite this market dominance, only last month (10^th March 2008) Google’s share price fell to it’s lowest in 12 months, $413 per share.[11]

So why is Google stagnating? The reasons for Google’s relative slump are many and varied; we could point to the global economic downturn affecting the share prices of many companies, or to the instability in the search engine market with Microsoft attempting to acquire Yahoo, this has surely had an impact; but shares in Google have been on the slide since Boxing Day 2007, 1 month before the Microsoft takeover plan was announced. Furthermore there is significance behind Google’s slump on the 10^th March 2008, this was the day before Google bought out online advertising agency DoubleClick for $3.1 billion. It’s not surprising that this substantial takeover bid put a large dent in the share price.[12]

There is an additional, very simple reason to explain the stagnation - Google aren’t making as much money as they were! The paid-search market in which Google leads the way works on a very simple principle - users click on hyperlinks to the websites of advertisers, and Google receives a small amount of money every time a user does this. Therefore, when users stop clicking on these advertisements Google will not make as much money. There are two factors causing this lowering in ‘clicks’ and thereby lowering in revenue. Firstly, as users become more aware of the way the World Wide Web works and the layout and function of the websites they use there is less need to click on adverts, many users will already have their favourite sites bookmarked and will be able to find what they want without the need to use the advert links. Secondly, Google has been in recent months improving the quality of its paid search system, the aim has been to prevent fraudulent clicks and accidental clicks by users, so this means less clicks and less revenue. So from a financial point of view this hardly seems like an improvement to the Google system. However, the measures that they have taken mean that the user clicks that do take place are more likely to be genuine and intentional and there is therefore a greater chance they will result in a sale for the advertiser. So while things look to be on the down-turn for Google, they will actually be able to charge more money for the reliable clicks that they do generate, Google income from advertising should start to balance itself out again soon.[13]

New Search Markets

The way in which we browse the Internet is changing rapidly, 5 years ago the concept of having Internet access on a mobile phone was quite alien, yet now it’s all part of the service. The recent launch of the iPhone has shown that the capabilities of a full web-browser can be transferred on to a mobile phone, making it easier and more attractive to use as an Internet device. The good news for Google is that it has been chosen as the default search engine on the iPhone, similarly Opera a browser used on many other Smartphones have opted to switch from Yahoo to Google as their default search engine.[14]

While some have argued that Google has ‘sold its soul’ in cooperating with the Chinese authorities, to censor various search results to Chinese Internet users, it is nevertheless a sensible business move. China has the world’s largest population and currently boasts the world’s fourth largest economy, and is growing rapidly. As China moves from industrialisation to digitalisation, Google has put itself in prime position to be the recipient of a huge windfall when China’s masses flock to the World Wide Web and use Google to search. Proposals have been put forward to ban censorship and to promote freedom of access across the world in line with Google’s ethos “Do no evil”. However, shareholders rejected a similar proposal last year and the Google board is recommending they do the same this year, clearly the financial rewards are greater than the ethical implications.[15]

The new geographical markets are not confined to China, consider India, another growing economy, the twelfth largest in the world and a population of 1.1 billion, not far off the 1.3 billon Chinese. Although India only has an ‘online population’ of 25 million, Google already claims 75% of this market, and as this technology becomes more a part of life across India the number of users is set to soar.[16]

King for a day, but what about tomorrow?

Everyone knows that e-business, particularly when it’s concerned with the world-wide phenomenon that is the Internet, is a fast-moving, ever-changing market place. Up until 5 years ago Microsoft was king, since then and currently Google is king. It seems to be the way of the world that a business will enjoy a time as ‘king’, leader in its market, the innovator, and the buzzword of the day. The Microsoft Network including Hotmail were once it, along with Yahoo, now it’s Google, but will Google like its predecessors be forced to move aside for the next bright, young business – who will be king tomorrow?

There is at present a worrying trend within Google. Senior staff, including several directors are leaving their posts at Google and heading for the offices of that new, bright young business – Facebook. Justin Rosenstein, formerly a top-engineer at Google wrote this of his new employer following his ‘defection’ to Facebook - “[Facebook is] the Google of yesterday, the Microsoft of long ago. That company where large numbers of stunningly brilliant people congregate and feed off each other’s genius. That company that’s doing with 60 engineers what teams of 600 can’t pull off.”[17]

At a glance this looks like a simple matter of a dent in Google’s pride, that they’re no longer the in business. While Facebook may well be the new fashionable place to work there are more profound reasons behind their luring of Google employees, it’s not simply that Facebook are trying to gain status points over Google, though that is undoubtedly a boost to their brand and a bonus for them!

A Changing Market

The question about the rise of Facebook and why they are seeking to recruit Google employees reveals something about the future of the paid-search market. Facebook and Google are not competitors (except in status and brand value), Google is operating in the paid-search market and Facebook in the social network area. But what is changing within these markets is the way in which businesses choose to advertise.

Adverting on social networks is it seems the new medium. Facebook boasts 68 million active users, that’s quite a market to sell your products to![18] But it’s not simply the number of users that make it an attractive place for advertisers to turn. A social network user will if actively involved enter plenty of personal information about themselves, initially the basics of age, gender and location, but also more specific information; their hobbies, films and music that they like, and writing notes about their lives. The great news for the advertiser is that adverts can then be targeted at specific users, making the adverts more relevant, and thus more likely to be clicked and to generate a sale. Facebook unveiled it’s new advertising system (Facebook Ads) less than one week after Google made an equally provocative announcement.[19]

Google being the innovators and competitors that they are, aren’t standing back and letting Facebook take all their advertising income. In November 2007 Google announced the launch of Opensocial, an open source platform to standardise the way in which social networks function. While Google may appear to be heroes for the open source movement in reality they are trying to build a social network that can compete with the increasingly dominant Facebook.[20] It’s worth mentioning that while Facebook is leading the way, particularly in the USA and the UK, that it’s not in China, a potentially massive client base which Google is already operating in. On top of their search services Google in China, Google are hoping to benefit from the social network market, very recently Google have started to invest in Chinese social network operator Comsenz, getting a foot-in-the-door as it were.[21]

Microsoft bids for Yahoo

On the 1^st February 2008 Microsoft offered $44.6 billion to buy Yahoo. This was a substantial offer, especially since Yahoo was only valued at $28 billion at the time of the takeover proposal. Yahoo responded on the 11^th February, rejecting this bid, although Microsoft remain confident that they will be able to secure the takeover in the not too distant future. This is not the first time Microsoft has attempted to acquire Yahoo, but the timing of this latest bid seems pertinent to our discussions for two main reasons. Firstly, the online advertising market is growing massively, at the end of 2007 it was worth $40 billion, by 2010 it is predicted that this will reach $80 billion, so it is only natural that a successful business like Microsoft would want to cut in on this market.[22] Secondly, Microsoft is undoubtedly troubled by the success and growth of Google, particularly as Google is increasing competing with Microsoft by slowly moving into the ‘Software-as-a-service’ market.

Software as a Service

Software as a Service (SaaS), is a model of software distribution where users don’t pay to own the software, but rather pay to use it. The distribution is done by creating a web-native format of the software package, using Web 2.0 technologies, allowing users to access the software which is hosted externally of the users’ organisation, either at the distributor or a 3^rd-party provider.[23]

Microsoft’s Sharepoint and Exchange software has long been a leader in the field of providing content management and other office related services to businesses and institutions over their intranets. It was announced recently that Sharepoint 2007 had broken the 100 million barrier for the number of licenses sold, generating over $1 billion of revenue. On the 3^rd March 2008, Microsoft chairman Bill Gates announced at the annual Sharepoint conference that Microsoft would be offering online versions of their Sharepoint and Exchange products – SaaS. But how is this related to Google?[24]

Google has already been busy in the SaaS market, the ‘Google Apps’[25] range provides the basic office documents (word processing, spreadsheet and presentation) which are compatible with Microsoft Office, as well as E-mail, Calendars and Instant Messaging. Last month Google announced another addition to the Apps package, Google Sites. This is a webpage/wiki building facility based on the technology of JotSpot, a company Google acquired in October 2006.[26]

It’s surely not a coincidence then, that as Google completes its Apps range (at least for now), now offering near identical facilities to Sharepoint and Exchange, that Microsoft has started to offer their services online as well, SaaS. Microsoft have only launched a Beta trial thus far, but are unlikely to be able to compete in terms of value for money, Google are offering a standard edition for free (up to 100 users), the premium edition is also free to non-profits and educational institutions, while to anyone else it will cost $50 per user, per annum. However, Bill Gates remains haughty when looking at the challenge of Google in recent conference address discussing the Sharepoint system he said - “In terms of Google, not to overstate it, but they really don’t understand the special needs of business. Today, their economic model is based on consumer search. They have done an incredible job there and obviously we’re investing in challenging them in that space…”[27]

Conclusion

It would seem foolish to suggest that it would be prudent to invest in a company that in the last year has seen its market value fall by $83 billion, but allow me to suggest why it is not. Google’s share price is currently at a similar level to what it was in December 2005, and appears to have reached a trough, from now on it does seem that the only way is up. While I’m not suggesting that Google will enjoy the massive gains of the previous year, I do believe its value will rise more steadily and will in time regain a value of around $700 a share. The reasons for this view are outlined in this document, but allow me to summarise them here:

• Google is providing a more reliable advertising system, where advertisers only pay for genuine users. This will encourage more advertisers to use Google. In addition, the acquisition of Doubleclick provides an increased client base.
• Massive new search markets are opening up around the world, from the improvements to mobile Internet, and the digitalisation of China, India and other rising global economies.
• Google continues to acquire businesses increasing their market, their influence and resources.
• Google is still the leader in search technology and a pioneer in Web 2.0 products, it will therefore continue to be able to sell its expertise to those who need it.
• Google is confidently entering into the business enterprise (SaaS) market, this is a massive market, even if Google can only claim a small percentage of this market, the revenue generated will be significant.

Google may currently be at a low ebb, but in reality it is standing at the gate to new opportunities and new markets. Google is coming out of a period of change and transition and is set to enter a new phase in its short history. An investment in Google may look like a risk, but it would be wise to invest while the giant sleeps.