Friday, September 5, 2008

On Google's Birthday

Now that Google is ten years old, let's have a little look at what's happened. When I first learned about Google, it was offering a search tool that didn't have any of the obvious trappings of a "portal" -- that is, no articles, news, or other things designed to trap visitors on Google properties. Google also, at that time, had yet to develop advertisement revenue. My initial inclination was to imagine that Google, like other dot-bomb startups, had no discernible mechanism for creating money and was simply burning up cash while being cool.

By the time Google actually offered shares to the public in 2004, it had developed a revenue stream from advertisements -- and not by selling search rankings. Google seemed committed to providing "honest" search rankings, and identifying to customers any advertisements as such. Could honesty work?

About the time Google offered its shares, some dismissed them as overpriced. Allen Sloan wrote, after the IPO had occurred, that although he had declared the IPO overpriced based on a share price of $108 or higher, its actual IPO price of $85 had yielded a "good buy" for participants. However, he proclaimed that the post-IPO price was too rich:
But now that the price is above the original minimum price range, I'm not in doubt. So I'll repeat what I said three weeks ago. This price is insane. And anyone buying Google as a long-term investment at $109.40 will lose money. (If you're buying Google to trade, assuming a greater fool will pay more than you did, you may do just fine. But I wouldn't wait too long to sell.) This has nothing to do with Google as a company: It's nicely profitable; I love the product. It has to do with math and with limiting factors -- fancy language for the old truism that no tree grows to the sky.
Allen Sloan, "IPO's Success Doesn't Justify Google's Price", Aug. 24, 2004.
At what price did Sloan declare Google a terrible long-term investment? $109.50. Four years later, and hundreds of additional dollars per share later, the consistently-profitable Google has yielded a 306% gain. Annualized, that's 42% per year.

Why are analysts so wrong on the companies they cover? Sloan himself offers some insight, just before explaining that he was wrong about his call against GOOG, but only because it actually IPO'd at 85 instead of at 108:
One of the tongue-in-cheek rules that we column-writers have is, "Often wrong, never in doubt." Take a stand, don't duck and weave too much. But someone as opinionated as I am should not only have no doubt, but shouldn't be wrong too often. No one's perfect, though.
Allen Sloan, "IPO's Success Doesn't Justify Google's Price", Aug. 24, 2004.
The problem is that he was wrong at 108, too, because he didn't "get" the size of the fish Google had hooked. Heck, the fish isn't on the boat yet: it could be bigger still.

Google is, after all, fighting now not just for the online advertising revenue it seems to dominate, but for the platform on which future applications and services will be delivered. Whether Google's platform is adopted, or some open-source competitor delivering compatible equivalents, Google wins. Exactly how will proprietary vendors keep the web locked up? Microsoft can't knife the baby when it lacks adequate leverage, and Google isn't in as precarious a competitive or financial position as was Netscape, which apparently was having trouble upgrading and modernizing its browser while the war was afoot.

As Google turns ten, it's got a lot to celebrate -- and many accomplishments to its credit. As a shareholder, I for one wish Google ten more of the same.


Anonymous said...

I just found your site. It's nice to see b/c 3 of my largest holdings are ACAS, AGNC and GOOG.

Any thoughts on GFG? To me, a nice LT value play on a bank w franchise value in TX and CA. Manageable NPAs and plenty of capital raised at $5 share from a local (R Rowling). Trading at $3. Nice.


Jaded Consumer said...

ACAS, AGNC, and GOOG? You didn't find my site by Googling those stocks, did you? :-)

I haven't researched GFC, but the financial sector will be a major beneficiary as the economy turns around. The question is whether this is soon, and which players are best suited to weather the storm. My own favorite financial at the moment is not a bank, exactly, but a play to participate in middle-market companies without having to find and buy them myself. Essentially I'm using American Capital as a mutual fund specializing in the size of companies I think will be in the best position to boom.

If GFC's current price reflects misunderstanding of the company rather than a sober evaluation of the future, it could be a deal. I've seen branches in Houston, but I haven't experience there as a customer. If you've got anything interesting on it, drop a link! In the meantime, the prospect of hard economic times makes cash-rich firms like AAPL and GOOG seem attractive, and low-leveraged firms like ACAS. AGNC is in a good position because its underlying investments have ended up backed by the federal government -- not just principal, but the timely payment of principal and interest -- so the remaining risk turns on interest rate spreads. I haven't seen the deals, but the 8+x leverage at AGNC is apparently achieved using repurchase agreements, among other things, raising the possibility that AGNC has limited its exposure contractually by arranging repurchases timed with its own debt obligations, making it possible to avoid 30-year obligations while scrambling every few months for a new debt rate. I'd like to better understand the financial engineering behind those deals. On the other hand, the fact that ACAS' board member has been tapped to lead Freddie Mac says something about ACAS' recognized depth of expertise in this field. I don't suspect AGNC blindly levered up without thinking about rate spread risks and offset expiration time frames between debts and investments.