Microsoft ($MSFT) continues to trade under US$20 a share.  We have previously looked at $MSFT and felt it was undervalued in the US$20-25 range.  We decided it was time to revisit our valuation.

Valuecruncher valuation model of $MSFT with interactive assumptions

Valuecruncher produces a valuation of US$25.34 for $MSFT. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 33.6% above the current share price of US$18.96.

Assumptions

• Revenue: Reuters aggregates 30 analysts covering $MSFT and the mean estimate of 2009 revenues is US$67.3 billion. For our analysis we have used US$64.0 billion in 2009, US$68.5 billion in 2010 and US$72.5 billion in 2011.  Between 2004 and 2008 $MSFT grew revenues at a compound annual growth rate of 13.2% - revenues of US$36.8 billion in 2004 to US$60.4 billion in 2008.
• Profitability: We have used an EBITDA margin of 40.0% to 2011. Reuters has $MSFT‘s EBITD margin at 39.25% last year and an average of 37.0% over the last five-years.
• Capital Expenditure: We have assumed capital expenditures of US$3.75 billion per annum moving forward.
• Discount Rate: 11.0%.
• Terminal Growth Rate: 3.0%. In our assumptions we have 2010/11 revenue growth at 5.8% - we have assumed that growth eventually slows to a 3.0% long-term stable growth rate.  We have used 3.0% as our terminal growth rate.

Our analysis incorporates the cash on the $MSFT balance sheet – Valuecruncher calculates a net debt number.

Comparator Analysis

Comparator analysis (sometimes called comparison company analysis) is a relative valuation approach. For $MSFT we looked at four peer companies - IBM ($IBM), Apple ($AAPL), HP ($HPQ) and Google ($GOOG). We calculated enterprise values - market capitalisation plus net debt (long-term borrowings less cash). Then we measured a range of metrics against the enterprise value for $MSFT and the peer set.

We have used the last financial year (LFY) as the base set of metrics. $MSFT is currently priced at the bottom of the peer group for the EV/EBITDA and EV/EBIT metrics and in the middle for the EV/FCF metric.  The market is currently valuing the profits (EBIT and EBITDA) and free cash flow produced by $MSFT at less than half that of the comparable numbers for $GOOG. This reflects the perceived different future growth prospects of the two businesses.  The comparator numbers show $MSFT is comparably priced against the peer group - even with the strengths of their business model (39.8% EBITDA margins vs 18.9% for $IBM and 11.7% for $HPQ).  $MSFT’s growth is slowing - but it is still a very good business.  Should $MSFT’s profits (at the EBITDA and EBIT levels) really be valued less than $IBM and $HPQ?

Play with our assumptions – what does your analysis say? We think that $MSFT looks undervalued.  Our model is interactive - you can change any of our assumptions.

Disclosure: None

Last week a Global Equities Research analyst Trip Chowdhry put out a research note laying out his argument for Google ($GOOG) posting negative revenue growth in the current 2008 year. Chowdhry’s analysis (and we have not seen the original full research note) has $GOOG posting revenues of US$15.71 billion in 2008 (5% below actual 2007 revenues of US$16.94 billion), US$15.23 billion in 2009 (3% below his 2008 projection) and US$14.57 billion in 2010 (4% below his 2009 projection). This analysis was picked up by a range of commentators that we really respect. These included analyst’s like Barron’s Eric Savitz, Silicon Alley Insider and Ashkan Karbasfrooshan. The only problem is that the analysis is deeply flawed.

At Valuecruncher we believe that top-down analysis can lead to flawed conclusions. Current trends can be mistakenly extrapolated out. We believe that you need to work from the bottom up. This appears to be a case of top-down analysis gone wrong.

Why?

Chowdhry’s 2008 revenue number appears based on currently deteriorating marcro conditions - remember 2008 revenues of US$15.71 billion. However, through three quarters of 2008 $GOOG has reported US$16.09 billion of revenues (through three quarters). $GOOG already has reported 2008 revenues above Chowdhry’s projection (through three quarters). Unless $GOOG announces negative Q4 revenues it is not going to be posting revenues for the 2008 financial year of US$15.71 billion.

So what do we think about $GOOG’s future revenues and the implications for valuation?

Valuecruncher valuation model of $GOOG with interactive assumptions

Valuecruncher produces a valuation of US$350.60 for $GOOG. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 11.0% above the current share price of US$315.76.

Assumptions

• Revenue: Reuters aggregates 26 analysts covering $GOOG and the mean estimates of 2008 and 2009 revenues are US$22.4 billion and US$27.9 billion respectively. For our analysis we have used US$21.5 billion in 2008, US$24.75 billion in 2009 and US$29.0 billion in 2010. Citi analyst Mark Mahaney has some assumptions around revenues that we are broadly in agreement with. Assuming Q4 revenues are in line with Q3 then 2008 revenues come in at US$21.635 billion.
• Profitability: We have used an EBITDA margin of 40.0% to 2010. Reuters has $GOOG‘s EBITD margin at 36.4% last year and an average of 36.0% over the last five-years.
• Capital Expenditure: We have assumed capital expenditures of US$2.75 billion in 2008 then US$3.0 billion per annum moving forward.
• Discount Rate: 11.0%.
• Terminal Growth Rate: 5.5%. In our assumptions we have 2009/10 revenue growth at 17.2% - we have assumed that growth eventually slows to a 4.0% long-term stable growth rate.

Our analysis incorporates the cash on the $GOOG balance sheet – Valuecruncher calculates a net debt number.

Comparator Analysis

Comparator analysis (sometimes called comparison company analysis) is a relative valuation approach. For $GOOG we looked at a two peer companies - Microsoft ($MSFT) and Yahoo ($YHOO). We calculated enterprise values - market capitalisation plus net debt (long-term borrowings less cash). Then we measured a range of metrics against the enterprise value for $GOOG and the peer set.

We have used the last financial year (LFY) as the base set of metrics. Of the peer group $YHOO is the closest direct competitor. But $YHOO has had a number of recent struggles and their LFY performance against $GOOG is not pretty. $MSFT’s numbers are an interesting comparison. $MSFT shows how far $GOOG still has to go from a financial perspective. $MSFT has over 3.6x the revenues of $GOOG (on a LFY basis). $MSFT’s financial performance is comparable to $GOOG. The market is currently valuing the revenues, profits (EBIT and EBITDA) and free cash flow produced by $MSFT at less than half that of the comparable numbers for $GOOG. This reflects the perceived different future growth prospects of the two businesses. That is an interesting observation - but to properly understand the implications you need to do the bottom-up analysis for each (probably using a discounted cash flow model).

Play with our assumptions – what does your analysis say? Our model is interactive - you can change any of our assumptions.

Disclosure: None

At Valuecruncher we have looked at Apple ($AAPL) twice over the last six-months. In June with the $AAPL share price at US$186.10 we produced a valuation of US$146.70. Then in September with the $AAPL share price at US$131.05 we had a valuation of US$163.98. We are now in early-December and $AAPL has continued to head south - with the market generally. $AAPL is now trading at US$94.00 - just over half the price we first looked at in June. We felt it was time to revisit the valuation of $AAPL from an intrinsic value perspective - and most importantly the assumptions that we are using. We have also completed some high-level comparator analysis looking at the current price of $AAPL against some broad peers using a range of metrics.

Valuecruncher valuation model of $AAPL with interactive assumptions

Valuecruncher produces a valuation of US$109.55 for $AAPL. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 16.5% above the current share price of US$94.00.

Assumptions

• Revenue: Reuters aggregates 29 analysts covering $AAPL and the mean estimate of 2009 revenues is US$40.6 billion. For our analysis we have used US$36.5 billion in 2009, US$43.5 billion in 2010 and US$49.0 billion in 2011.
• Profitability: We have used an EBITDA margin of 19.0% to 2011. Reuters has $AAPL‘s EBITD margin at 20.8% last year and an average of 16.8% over the last five-years.
• Capital Expenditure: We have assumed capital expenditures of US$1.15 billion per annum moving forward.
• Discount Rate: 11.0%. In our June valuation we used a discount rate of 11.0% but dropped that to 10.0% in September. We believe 11.0% is a reasonable assumption in the current market conditions.
• Terminal Growth Rate: 4.0%. In our assumptions we have 2010/11 revenue growth at 12.6% - we have assumed that growth eventually slows to a 3.0% long-term stable growth rate.

Our analysis incorporates the cash on the $AAPL balance sheet – Valuecruncher calculates a net debt number.

Comparator Analysis

Comparator analysis (sometimes called comparison company analysis) is a relative valuation approach. At Valuecruncher we have previously looked at comparator analysis.  For $AAPL we looked at a range of broad peers.  We calculated enterprise values - market capitalisation plus net debt (long-term borrowings less cash).  Then we measured a range of metrics against the enterprise value for $AAPL and the peer set.

We have used the last financial year (LFY) as the base set of metrics.  Of the peer group $EBAY and $YHOO had rough LFY performance.  The other numbers are interesting.  The one that stands out a mile to us however is that $AAPL is currently trading at 7.0x last years free cash flow (FCF).  Remove the cash and you can have the business for 7.0x last years FCF - no growth assumed.  Wow - that looks cheap.

Using our valuation of US$109.55 that gives a EV/FCF multiple of 8.7x.  That is still pretty resonable compared to the peer set.

Play with our assumptions – what does your analysis say?

Disclosure: None

$GOOG announced stronger than expected third quarter financial results today.  This resulted in a US$13.85 (4.08%) lift in the share price to close at US$353.02 – and more in after-hours trading.  This is still less than half the 52-week high of US$747.24.  This is a good result for $GOOG in volatile market conditions.  We decided to have a look at $GOOG with the Valuecruncher interactive tool to place an estimate on the intrinsic value of the company using a discounted cash flow valuation.

Valuecruncher valuation model of $GOOG with interactive assumptions

Valuecruncher produces a valuation of US$416.73 for $GOOG.  This is a current valuation (an estimate of intrinsic value) not a target price.  This valuation is 18.0% above the current share price of US$353.02.

Assumptions

In 2007 $GOOG had annual revenues of US$16.6 billion and an EBITDA margin (profits) of 40.7%.  Reuters aggregates 26 analysts covering $GOOG and these have mean estimates of 2009 and 2010 revenues of US$22.4 and US$27.9 billion respectively.  For our analysis we have used US$22.0 billion in 2008, US$27.0 billion in 2009 and US$32.5 billion in 2010.  We have forecast EBITDA margins remaining flat at 40% to 2010.  We have estimated capital expenditure in 2008 at US$3.075 billion rising to US$3.75 billion in 2010 and at US$3.25 billion beyond that.  Capital expenditure dropped dramatically in quarter three to US$452 million from US$697 million the previous quarter.  We don’t believe that capital expenditure will remain at the current level (Q3).  All of these assumptions can be amended in the Valuecruncher on-line valuation model to adjust the valuation.

Other Model Assumptions:

Discount Rate: 11.0%.  We believe the discount rate is in the 9-11% range.  We have used the upper end of this range to reflect the uncertain market conditions that $GOOG signalled in the announcement.

Terminal Growth Rate: 6.0%.  The US economy grew at an average of 3.6% over the last five-years.  $GOOG showed that while growth is slowing there is still more to come.

Our analysis incorporates the cash the $GOOG balance sheet – Valuecruncher calculates a net debt number.

Based on our analysis and assumptions the current share price is at a discount to intrinsic value.  Play with our assumptions – what does your analysis say?

Disclosure: None

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

Valuecruncher has recently completed a valuation of $GOOG and previous also completed a multiple scenario valuation for the company. Our recent valuation came out at US$493.88. Henry Blodget in Silicon Alley Insider came out this week with an argument for a fair value of $GOOG being US$300-375 per share. This was based on a multiple (20-25x) of free cash flow and backed by a report that $GOOG is aiming internally for 15% revenue growth next year (2009). We thought that we would revisit our valuation and have a look at Henry’s assumptions in a DCF valuation.

First of all we want to applaud anyone with an audience that talks about valuation with some numbers attached. As we have said previously – in our experience most people don’t run any numbers at all.

Our perspective here is looking at the intrinsic value of $GOOG. Our approach is to start with a DCF and then potentially look at multiples. For that reason we would put aside the 20-25x free cash flow as a starting point and begin with more fundamental analysis. We started with the report of $GOOG internally targeting 15% revenue growth next year (2009). We fleshed that out with some of our own assumptions. Assuming revenues of US$22.5 billion in 2008 we assumed 15% revenue growth in 2009 and 12.5% 2010. We used an EBITDA margin of 37.5% in 2008 rising to 40% in 2010. We used a discount rate of 10% and a terminal growth rate of 5.0%. For CAPEX we assumed US$3.0 billion in 2008 and US$3.5 billion beyond that. We accept that we are adding quite a bit to Henry’s starting point.

Valuation of $GOOG using 15% 2009 revenue growth starting point

This valuation comes out at US$352.67. This is in the middle of the US$300-375 range Henry talks about as fair value using the 20-25x free cash flow metric. Based on these assumptions Henry’s numbers are reasonable. But are these assumptions reasonable?

The revenue target is the easiest starting point. $GOOG did US$16.6 billion in revenues in 2007 – assuming analyst estimates are correct and $GOOG makes the US$22.5 billion 2008 revenue consensus. A 15% increase in 2009 takes revenue to US$25.9 billion in 2009 and a 12.5% increase in 2010 is revenues of US$29.1 billion. This compares to consensus estimates for 2009 of US$28.4 billion. The analyst projections may be off – but that far off? We don’t believe a drop off in on-line advertising spend will impact $GOOG anywhere near as deeply as that - but that is the big question.

Our view is that 15% revenue growth in 2009 looks way too low for $GOOG. Current consensus estimates are 26% revenue growth. The 20-25x free cash flow metric also seems arbitrary. We struggled to find a comparable to make that relevant. We are sticking to the DCF approach. We are also sticking with our earlier valuation numbers for $GOOG. We don’t agree with Henry - we think $GOOG looks cheap. But everyone is entitled to their own assumptions.

Valuecruncher valuation model of GOOG with interactive assumptions

All of this analysis incorporates the cash on the GOOG balance sheet – Valuecruncher calculates a net debt number. All of the assumptions can be amended in the Valuecruncher on-line models to adjust the valuations.

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

Disclosure: None

Valuecruncher has previously completed a valuation of GOOG using a scenario approach. We started with a base case before looking at growth, disruption, and black swan scenarios. GOOG was trading at US$542.30 when we completed that valuation. Our base case was US$481.94 with our low-end disruption scenario at US$363.22. With GOOG trading at US$430.14 we thought it was time to update our base case valuation.

Valuecruncher valuation model of GOOG with interactive assumptions

Valuecruncher produces a valuation of US$493.88 for GOOG. This is a current valuation not a target price. This valuation is 15% above the current share price of US$430.14 (note our model picks up an earlier price of US$449.15 because we completed the valuation earlier). This isn’t materially different to our earlier base case valuation of US$481.94.

Assumptions

Our assumptions are revenues of US$22.25 billion in 2008 growing to US$33.75 billion in 2010. We have used a flat EBITDA margin of 40% to 2010. We used a terminal growth rate of 6.0%. We used a terminal capital expenditure number of US$4.0 billion. We have used a WACC (discount rate) of 10.0%. All of these assumptions can be amended in the Valuecruncher on-line model to adjust the valuation.

Our analysis incorporates the cash on the GOOG balance sheet – Valuecruncher calculates a net debt number.

Based on our analysis the current share price looks cheap. It appears a great opportunity to be buying GOOG. Play with our assumptions – what does your analysis say?

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

In our experience, most private investors don’t complete fundamental financial analysis on prospective investments.  They often recognise this and say they would like to do more – but “it is hard work”.  They are right – but running financial analysis on prospective investments, even at a high-level, is a vital step in making quality decisions.  The professionals don’t pull the trigger without running the numbers.

One of the aims of our Valuecruncher interactive tool is to make it easier for people to complete fundamental valuation analysis using a discounted cash flow valuation methodology.  Here is our quick guide to completing a high-level discounted cash flow valuation analysis in five-minutes.  We have chosen Microsoft (MSFT) as the example company.

The default Valuecruncher interactive tool is a starting point for the valuation of companies in our database.  Instead of having to build a discounted cash flow model and source the various company projections – Valuecruncher gives you the valuation model and starting inputs.  We start on the MSFT company page.

Valuecruncher MSFT Company Page

To get started – hit the “Create Your Valuation” button.  This takes you to the default Valuecruncher valuation for MSFT.  This default valuation isn’t a recommendation it is a starting point to create your own valuation.

Profitability

The profitability tab covers the company’s anticipated revenues and profitability (at the EBITDA level).  The starting numbers in the default valuation are based on estimates of the company’s prospects moving forward.  To complete a high-level valuation of MSFT we round the revenues to three significant figures – US$67.5 billion in 2009, US$74.5 billion in 2010 and US$79.4 billion in 2011.  We have used a flat EBITDA margin of 40% to 2011.

Key Valuation Assumptions

Discount Rate – reflects the required rate of return on an investment. The discount rate consists of two key components, the time value of money and risk.  The discount rate used in the Valuecruncher valuation is the nominal post-tax weighted average cost of capital (WACC).  The higher the discount rate the more variable (greater risk) the cash flows generated by the company.  For US companies we would expect to see discount rates in the 8-12% range – 8% being stable utility style businesses and 12+% being riskier technology-based companies.  For MSFT we have used a 10% discount rate.

Terminal Growth Rate – is an approximation of the growth rate beyond the next three years into perpetuity (i.e. forever) of the company’s cash flows. The company’s growth rate will fluctuate with economic and industry cycles with the terminal growth rate representing an average growth rate.  The long-run expectation for economy wide growth is approximately 2-3% (nominal).  We have a blog post with a table showing how to estimate terminal growth.  But the place to start is 2-3% + a factor for near term growth.  We have completed a valuation for Google (GOOG) that used a 6.5% terminal growth estimate – that is pretty high.  You would expect to typically see terminal growth in a 2-4% range.  For MSFT we have used 3%.

Tax – The tax rate entered is used to calculate the tax payable for the first three years. Beyond that the marginal tax rate of the country of domicile is used.  For MSFT we have used 35%.

Capital Expenditure / Depreciation

How much does the company have to spend to generate the revenues and profits for the business?  Capital expenditure is a cost that is not included in the revenue or EBITDA margin assumptions.  This covers: the acquisition or disposal of operating assets, research and development costs not included in the EBITDA margin and changes in net working capital.  The terminal capital expenditure represents an estimate of the ongoing investment required to facilitate the forecast long term growth. The terminal capital expenditure value should be viewed as a simplified estimate of a more complex series of expenses.  For MSFT we have assumed capital expenditure of US$3.25 billion in 2009, US$3.75 billion in 2010 and 2011 then terminal capital expenditure of US$4.0 billion.  We have assumed depreciation of US$2.75 billion in 2009, US$3.0 billion in 2010 and US$3.25 billion in 2011.

That is it – 16 variables with default numbers provided.  Other inputs from the balance sheet that form part of a net debt calculation (long-term borrowings and cash) are calculated automatically by Valuecruncher based on the latest balance sheet numbers.

This gives us a valuation for MSFT of US$30.86 – 25.6% above the current share price of US$24.57.  Based on this high-level analysis MSFT looks cheap.

Valuecruncher valuation model of MSFT with interactive assumptions

With a valuation created it now appears on the company page for others to see.  Other users can create their own valuations or they can then take the assumptions from an existing valuation and change ones they choose to create a separate valuation.  Saving changes to a valuation simply creates a new valuation.

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

A US fund manager Manning & Napier has come out with an amazing call in Barron’s that their current view of the Google (GOOG) share price equates to US$950-1,050. Henry Blodget works through some of the assumptions and is not convinced.

Neither are we.

We took the assumptions from Henry Blodget’s analysis in Silicon Alley Insider and ran these through the Valuecruncher on-line valuation tool to see what sort of numbers are required to justify a US$1,000 a share valuation for GOOG.

Assumptions – for a US$1,000 a share valuation for Google today

We started with a 2008 revenue number of US$22.5 billion – and then grew that at 30% per annum to 2010. We used a 40% EBITDA margin on these revenues. We used a US$4.25 billion terminal capital expenditure figure. For a discount rate (WACC) we used 10%.

These are aggressive projections for the period to the end of 2010. But where things get really wild is in determining the terminal growth rate. This is the rate that reflects the growth potential beyond 2010. To achieve a valuation over US$1,000 a share we have needed an 8% terminal growth rate. This is a big number. How big. To get to an 8% terminal growth rate requires a 30% growth rate from 2010 to 2011 then dropping to 6% in perpetuity from 2015. The growth numbers look like 24% in 2012, 18% in 2013, 12% in 2014 and 6% in 2015 and beyond. 6% is a big perpetuity number – 8% is huge. Play with the assumptions and see the impact. Note: in our model the terminal growth rate must be more than 2% below the discount rate. In this example we come up against this constraint.

Valuecruncher valuation model of US$1,000 Google share price with interactive assumptions

Our analysis incorporates the cash on the Google balance sheet – Valuecruncher calculates a net debt number.

Here at Valuecruncher we do not believe that Google is worth over US$1,000 a share. The assumptions required are just too heroic to be realistic. A month ago we completed a scenario valuation for Google. We still stand by that as a way to look at and think about the valuation of Google.

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

Microsoft (MSFT) is in an interesting place at the moment - which is only in part to losing Bill Gates from day-today management. It created one of the dominant global businesses of the late 20^th century but has struggled to move beyond the core products that drove this success. The Client (Windows), Server and Tools (enterprise solutions) and MBD (Office) divisions drive 83% of revenues and over 100% of operating profits (the On-line Services and Entertainment divisions are still operating at a loss). Microsoft has spent a lot of money and resources (especially senior management focus) on the aborted (maybe) attempt to acquire Yahoo (YHOO). We agree with the analysis that the pursuit of Yahoo is an attempt to compete with Google (GOOG) in what has become one of the dominant global businesses of the early 21^st century (on-line advertising driven by search). The Microsoft acquisition of Powerset is a further example of this strategy of aiming to compete directly with Google.

At Valuecruncher we are not convinced by this strategy of competing with Google - we are not alone. We completely respect Microsoft’s previous successes in following into and then dominating markets. But in the on-line advertising and search market we see some of the same network effects that suggest a “winner takes all” competitive situation. At Valuecruncher we can see a situation where Google’s current dominance is eroded – but not because of a head-to-head battle with either Yahoo or Microsoft (or a potential combination). At Valuecruncher we believe that Microsoft should be looking beyond the current competitive situation to the next big profit pool. Hockey great Wayne Gretzky when asked about why he was successful is credited with the quote “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be”. Easily said we recognise, but that is our view of where Microsoft should be directing their strategic efforts – not competing head-to-head with Google in a market their competitor dominates.

Any potential acquisition of all, or part, of the Yahoo business clouds any current valuation discussion of Microsoft. Some influential Microsoft insiders have suggested in a piece of high-level analysis that 1% of the global search market is worth US$1 billion in market capitalisation. Microsoft’s potential acquisition of Yahoo valued their share of the search market at more than that - US$47 billion for approximately 20% market share. What about the core Microsoft business? What if we ignore the potential Yahoo scenarios – what is the core Microsoft (MSFT) business worth?

The core Microsoft business is reasonably easy to value – if you exclude growth options. The business is growing well (if not at the levels of ten years ago) with robust margins. There is capital expenditure required to achieve the revenues and profitability. There is strong competitive positioning around these core products but with credible low-end competitors that have the potential to disrupt (i.e. Google Docs). The current business will change as technology develops – but as the current dominant player, Microsoft is well positioned to respond to competitive threats and to potentially lead innovation. At Valuecruncher we are not sure that Microsoft should be investing heavily in the on-line advertising and search market - they should be aiming beyond it.

MSFT Valuation

Microsoft grew revenues from US$36.8 billion in 2004 to US$51.1 billion in 2007 – an 11.5% compound annual growth rate. Our assumptions of revenues for the next three years are US$60.0 billion in 2008 growing to US$74.0 billion in 2010 – a 13.1% compound annual growth rate. We have projected EBITDA margins to be flat at 40%. We have used a terminal growth rate of 4.5%. We calculated this terminal growth rate based on year three growth of 10.4% dropping to a 4% stable growth rate by year 10. We used a terminal capital expenditure number of US$3.0 billion. We have used a WACC (discount rate) of 10.5%. Both the terminal growth rate and WACC have a material impact on the valuation.

Valuecruncher Valuation MSFT

Our analysis incorporates the cash on the Microsoft balance sheet – Valuecruncher calculates a net debt number.

Our analysis gives a valuation of US$33.01 which is 20% above the current share price of US$26.03. The market appears to be placing a negative value on the noise around an acquisition of all or part of Yahoo. Focusing on the harvesting the core business and innovating (by making small bets) beyond that core appears to be the highest value strategy for Microsoft.

Based on our analysis the core business looks undervalued. Play with our assumptions – what does your analysis say?

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

We are revisiting a prior piece of analysis we completed on Google (GOOG). It has been a popular piece of analysis and we wanted to update the analysis using our on-line valuation tool.

GOOG Valuation

Google grew revenues from US$3.2 billion in 2004 to US$16.6 billion in 2007 – a huge 73% compound annual growth rate. Our assumptions of revenues for the next three years are US$22.5 billion in 2008 growing to US$34.5 billion in 2010 – a 27% compound annual growth rate. Year-on-year revenue increases have slowed from 92.5% in 2005 to 56.5% in 2007. We are projecting revenue growth to continue to slow – 35.6% in 2008, 26.7% in 2009 and 21.0% in 2010.

We have projected EBITDA margins at a flat 40%.

We have used a terminal growth rate of 6.5%. We calculated this terminal growth rate based on year three growth (2009 to 2010) of 21% dropping to 18.5% in 2011 and then to a 5% stable growth rate over the next ten years.

We have used a WACC (discount rate) of 10.5%. The WACC (discount rate) has a material impact on a discounted cash flow valuation (as does the terminal growth rate). We think this WACC of 10.5% is reasonable but recognise that the actual number could be as low as 10% or as high as 12-12.5%.

We used a terminal capital expenditure number of US$4.25 billion.

Our analysis incorporates the cash on the Google balance sheet – Valuecruncher calculates a net debt number.

Our analysis gives a valuation of US$481.94 which is 11.1% below the current share price of US$542.30.  Our valuation is based on the current share price - it isn’t a target price for the future.

Valuecruncher Valuation GOOG – Base Case

We 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 we have increased the terminal growth to 7.0% – based on 2011 growth of 20% decreasing to 5% over ten years – and lifted EBITDA margins to 42.5%. This scenario has a valuation of US$590.39 per share. This is 8.9% above the current share price and 22.5% above our base case valuation.

Valuecruncher Valuation GOOG – Growth

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 we have decreased the terminal growth to 5.5% – based on 2011 growth of 15% decreasing to 4% over ten years – and dropped EBITDA margins to 37.5%. This scenario has a valuation of US$363.22 per share. This is 33.0% below the current share price and 24.6% below our base case valuation.

Valuecruncher Valuation GOOG – Disruption

3. Black Swan – where Google’s internal activities create a new growth business similar in value to Salesforce.com. The new business grows from US$250 million in revenues in 2009 to US$1.5 billion in 2012 and from $250m in losses to 50% EBIT margins in the same period. To reflect this we have increased 2009 revenues by US$250 million and 2010 revenues by US$500 million. We have reduced the 2009 EBITDA to 39%. We have also lifted the terminal growth to 6.65%. This scenario has a valuation of US$507.85 per share. This is 6.4% below the current share price and 5.4% above our base case valuation. Google creating a new business of the value of Salesforce.com adds just under US$26 to our base case share price.

Valuecruncher Valuation GOOG – Black Swan

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 conversely 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 business unit (say US$1.5 billion of revenues by 2012 at 50% EBIT margins). The value of this new business unit is ~US$8.1 billion in the valuation – comparable to the current enterprise value of a Salesforce.com.

Play with our assumptions – what does your analysis say?

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