Putting A Value On Google, Part 2
As The Eagerly Awaited IPO Draws Near, S&P Takes Another, Updated Look At The The Search Giant's Likely Worth
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(Editor's Note: This article is an excerpt from the full report. Full .pdf versions of Part 2 of the Google Pre-IPO report, as well as Part 1 and the Search Engine Survey conducted for S&P, can be purchased directly at http://sandp.ecnext.com -- Adobe Acrobat is required. Additional information on Standard & Poor's pre-IPO coverage on Google can be found at http://www.standardandpoors.com/pre-ipo)
The Internet search leader anticipates the offering price for its shares will be between $108 and $135. Using the 268.5 million diluted shares outstanding the company expects following its IPO, Google would have a market capitalization of $29 billion to $36 billion. And while some market commentators have remarked that the deal may represent a return to valuations reminiscent of early 2000, we believe this range is reasonable.In Part 1 of our Pre-IPO Report, we indicated that based on comparisons to Yahoo (YHOO; recent price, $26; S&P investment rank, 3 STARS, hold), Google's most comparable peer in our opinion, our preliminary estimated market value for Google was from $33 billion to $40 billion. Part 1 was focused on Google's businesses, industry, and competitive position, and included brief valuation analysis. In this report, we more thoroughly consider the company's potential value.
COMPARABLE REVENUES. In our June report, we employed relative analysis involving Yahoo to derive a preliminary valuation for Google. Now, we revisit this analysis, and utilize three additional comparative methodologies as part of our assessment to determine the company's potential value. (Note that our relative analysis was done using prices as of July 27, and Internet stocks have fallen notably since then.)
Updating our previous initial valuation analysis with revised estimates and ratios, we derived the same range for Google's potential market capitalization as we did in June ($33 billion to $40 billion). Following details released in late July, we are also able to derive possible per-share values of $121 of $147. Our updated 2004 forecasts for Google are revenues of $3.0 billion, gross profit of $1.5 billion, and earnings before interest, taxes, depreciation, and amortization (EBITDA) of $1.1 billion.
While our estimates for gross profit and operating cash flow are largely unchanged from our June report, our revenue forecast is different. In late July, Google began reporting gross revenues instead of net revenues. We believe Google made this change so that its financials would be more comparable to those of other Internet companies.
Yahoo recently traded at 12 times sales, 19 times gross profit, and 40 times EBITDA. If Google traded between a 10% discount and a 10% premium to these multiples, its aggregated valuation ranged would be $33 billion to $40 billion. Thus, although Yahoo's valuation has fallen since Part 1 of our report was published, Google's reported and estimated revenues are in effect higher, leading to the comparable valuation assessment.
Updated Yahoo Valuation Analysis ($ in billions, except price per share and ratios)
Financial ProjectionsYahooGoogle
2004E Revenues$3.30 $3.00
2004E Gross profit$2.20 $1.50
2004E EBITDA$1.00 $1.10
Valuation Metrics
Market capitalization$40.40 $32.5-$39.7*
Price per share$30.00 $121-$148*
Price-to-sales12X11X-13X
Price-to-gross profit19X17X-21X
Price-to-EBITDA40X36X-44X
Note: projections and metrics are as of July 27, 2004
* Estimates
Source: Standard & Poor's Equity Research Services
Taking this analysis further, we compared Yahoo, as well as three other prominent Internet companies, Amazon.com (AMZN; $38; 3 STARS), IAC/InterActiveCorp (IACI; $27; 4 STARS, accumulate), and eBay (EBAY; $77; 5 STARS, buy), to Google. We believe Yahoo is Google's most comparable peer, primarily because both companies derive most of their revenues from online advertising.
We also included three smaller companies -- Ask Jeeves (ASKJ), FindWhat (FWHT) and LookSmart (LOOK), none of which is followed analytically by S&P -- focused primarily on online search. We compared Google to these large-cap and search-focused Internet companies, based on a variety of valuation criteria. Our consolidated relative analysis suggests that Google's indication of its stock pricing at $108 to $135 is reasonable, with some of our calculations suggesting potential values as low as $55 and as high as $148. Averaging the ranges derived from our four valuation methodologies yields a possible stock price of $86 to $105 (whose mid-point is $95.50).
We believe that although comparative analysis offers insight as to value, intrinsic considerations are also a critical component in valuation assessment, because they allow for the inclusion of explicit growth assumptions.
GOING DUTCH. Using discounted cash-flow calculations for a private company requires many assumptions. Because Google's stock has not started trading, we had to estimate its possible beta -- a widely used measure of a stock's volatility. We estimated it at 25% higher than Yahoo's beta, reflecting uncertainties as to the Dutch auction, Google's current non-public shares, its expected limited float, and likely disparities in analyst expectations (reflecting the company's limited operating history and indications it will not provide financial guidance). This beta (2.0) reflects an expected high degree of relative share volatility, and yielded a relatively high discount rate of 17.4%.
We project annual free cash flow (FCF) will more than double on average over the next three years, trending down to 44% growth from 2007 to 2011, and to under 10% for the seven years thereafter. Our expected perpetuity growth rate for the years to follow is 3%. Based on these assumptions, we derive a possible intrinsic value of $161 per share. Our sensitivity analysis indicates that changes in inputs such as beta, our initial FCF estimate, and rate of perpetuity growth would have a material impact on our intrinsic value calculation.
Discounted Cash Flow Sensitivity Analysis
ChangeIntrinsic ValueRelative Change of Intrinsic ValueWACC
Change in beta+0.1$150.52-6.39%18.02
Change in Debt/Equity+10$184.7114.87%16.21
-10$141.06-12.28%18.63
Change in 2004 FCF forecast+10%$176.8910.00%17.42
Change in rate of+1%$164.732.44%17.42
perpetuity growth-1%$157.38-2.13%17.42
Source: Standard & Poor's Equity Research Services
Google's SEC filings include some clues as to what the company has determined as a fair value for its stock. Specifically, for the purposes of financial accounting related to stock-based compensation for employees, the company has engaged in valuation analysis not all that dissimilar to what we have done in this report. Google has utilized relative and intrinsic analyses in valuing the stock options it has granted to its workers.
NO SURPRISES. In the second quarter of 2004, Google incurred deferred compensation expenses associated with stock options of $74.8 million. The company granted 965.5 million stock options during the quarter. Dividing the deferred compensation by the number of options issued yields $77.43 per share in unearned compensation. Adding to this amount the weighted average strike price of the options of $38.43, results in an implied per-share value of $115.86. In the first quarter, the same analysis indicates Google valued its stock at $91.98, suggesting 26% appreciation from the first quarter to the second.
And with our various analyses completed, we set out to arrive at a final valuation for Google's public debut. Taking the average of the possible valuations we calculated using relative analysis, intrinsic analysis, and option analysis results in a potential per-share price for Google of $121 to $127 -- within the indicated price range of $108 to $135 set forth in its July 30 SEC filing.
Copyright 2004
, by The McGraw-Hill Companies Inc. All rights reserved.
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