Last week New York-based venture capitalist Fred Wilson wrote a blog post on his decision to buy some Google shares which also linked to his Covester account where you can track actual investment transactions of members.  The blog and Covester posts outline the “back of the envelope” calculations that Fred did in deciding to buy the shares.  Fred’s calculations are pretty basic – which is what most people (including very smart people like Fred) do.  At Valuecruncher we try to take the analysis step a little bit further.

Here is our take on Google:

Valuecruncher places a mid-point valuation on Google of $511 per share.  This is based on annual revenue growth decreasing from 35% in 2008 ($22.4 billion in revenues) to 15% in 2012 ($50.2 billion) then decreasing to a 5% terminal growth in 2018. Valuecruncher projects a 35% EBIT margin being maintained over this period - $7.8 billion in 2008 to $17.6 billion in 2012.  Valuecruncher projects capital expenditure growing to $4.5 billion in 2012 and remaining at that level.  Valuecruncher uses a discount rate of 10.5% and a 30% effective tax rate in the DCF calculation.

Valuecruncher has then created three separate scenarios:

1. Growth - where Google’s current dominance of on-line search and advertising is enhanced and revenues grow faster than anticipated in the base case.  This scenario holds all the inputs from the base case constant except that revenues growth decreases at a slower rate from 35% in 2008 to 25% in 2012.  This scenario has a valuation of $631 per share.  This is 34% above the current share price and 23% above our valuation.

2. Disruption - where Google’s current market dominance is reduced by changes in the competitive landscape.  This scenario holds all the inputs from the base case constant except that revenues growth decreases from 35% in 2008 to 25% in 2009 then to a flat 15% to 2012.  This scenario has a valuation of $426 per share.  This is 10% below the current share price and 17% below our valuation.

3. Black Swan - where Google’s internal activities create a new growth business similar in value to Salesforce.com that is separate to the current business.  The new business grows from $250m in revenues in 2009 to $1.5bn in 2012 and from $250m in losses to 50% EBIT margins in the same period. This scenario has a valuation of $533 per share.  This equates to a 5% increase on the current share price or 4% on our valuation.

Valuecruncher greatly respects Google’s current market dominance in search and on-line advertising.  However – we can see both a situation where Google maintains this dominance and more advertising spend moves from traditional media to on-line and one where new methods of discovery on-line disrupt Google’s current dominant position.  We do not have a perspective on which of those might occur – but it is worth considering the impact of both scenarios from a valuation perspective.  These are scenarios 1 and 2.

Our third scenario looks at the valuation impact if one of the internal Google R&D activities produces a material new company ($1.5 billion of revenues by 2012 at 50% EBIT margins) that is separate to the current Google business.  The value of this new entity is $6.8 billion in the valuation – comparable to the current enterprise value of a Salesforce.com.

Details of the base case valuation and three scenarios are included in the attached valuation report.

Valuecruncher Valuation Report - Google 3 March 2008

This entry was posted on Monday, March 3rd, 2008 at 4:10 pm and is filed under Google, International. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.