GOOG: The Day After
I was speaking to the CEO of networking company last night and he surprised me with the comment that he used to read my blog and thought highly of my blog. I have not blogged in four years. Now I am back blogging because I have some time to commit to blogging. I have written blog post that disagree with the notion that blogging should be live in the moment, extemporaneous thought stream. I attempted to be thoughtful and compose original pieces. I am not sure how long I will sustain this blog, it could be a matter of days or months, but I though this was a good opportunity to read something I posted in 2006 and see if it still made sense in 2011. Below this post is my unedited 2006 post on Google.
Today is an apropos day to write about Google as they reported earnings last. A number of disappointing metrics have clipped the stock today. There is nothing wrong with Google. It is a fantastic company – they just make so much money it is hard for their other businesses to live up to the success of the core business. I had one VC comment to me lately that he thought Google funds all sorts of wild, fantastic projects and people because they make so much money it would look obscene if they just spent what was needed to run the core businesses.
Here are my thoughts on Google post the report. If you want to see a company that is going to kill RIMM, it is Google. I would take the long GOOG, short RIMM trade all day. In many ways, Google is one of the critical computing engines of the internet. If you want to be long GOOG, what should you expect the stock to do?
If we look at a weekly chart that removes the distraction of daily swings and assume that 2007 run to the peak and the 2008 run to the bottom did not occur, then the stock is actually showing a toping pattern. See the five black lines of higher highs; they are starting to lose their step function. Barring a major market sell off, I think the stock is going to become range bound in the $505-625 range. The good news is I think the recent management change is a reflection the stock for what we know about the company is in a fully valued position. I would be buyer and holder long term because I think the management team (1) knows this and (2) long term I like their position in a compute centric internet world.
Friday, September 29, 2006
Thinking About Google, Do they Fit into a Peer Group?
How would you classify or label Google as a company? Are they an ASP, Search Engine, Services Portal, New Millennium Service Provider, Infrastructure Provider, Software Company or something else? Google does receive a large amount of press and even has nice 60 Minute fluff pieces done on the company wherein we learn that the smartest people on the planet are lovingly clustered in one location ensuring that we can have immediate access to information regarding the nearest pizza shop and Starbucks location.
Google defines their company mission as: “Google’s mission is to organize the world’s information and make it universally accessible and useful.” [Source: http://www.google.com/corporate/]. This mission statement is accurate when you accept the premise that the Google business model is really a function of their user base and their ability to connect users with advertisers. By this definition, growing the subscriber base means having presence in demographic markets with large populations, consumer level wealth and connections to the web whether it is wired or wireless. I like Google’s mission statement, but I always think that a better mission statement for a public company would be: “We are here to enhance and grow shareholder value through an ethical application of our business model.”
Critical to the success of Google’s business model is having relevant content and recognizable brand. I wrote about the content portion last week [see http://wrkoss.blogspot.com/2006/09/do-you-want-to-own-content-aggregate.html], thus we only need to cover the brand portion. Google as a brand is a core element of their success. If Google was not a brand at the consumer level, they would not be a preferred destination on the web and would not be generating vast amounts of advertising revenues. Having relevant content and recognizable brand are key components to their success.
What does Google do well?
Google does three things well. (1) The have an excellent search engine built initially around the concept of ordering an information database by using the concept of source citing and links to data. Think back to the concept of creating a graduate thesis and citing sources. As information evolves, papers the theories evolve from base of existing knowledge. Credible academic papers cite sources and previously published material. Google’s initial search engine started with the concept of ordering information based on relevancy measured by links or references to the content from other sites. (2) Google figured out how to monetize the information in their library. By separating sponsor information from ordered or non-sponsored information Google actually created a space to brand and value. (3) Google does services very well and the core service is what Mary Meeker termed an “on demand customer acquisition tool.” I heard Mary describe Google in this way at the Warburg-Pincus Information Technology Conference in May 2006. Mary went on to state that Google provides “…advertisers and vendors with a toolset, dashboard to manage and measure customer acquisition through sponsored search.” As evidence of this point, Meeker used the Q4 Google numbers (now somewhat dated) that revealed Google generated $1.9B in gross revenues and paid out $629M to partners.
What Google does not do?
Google is not an infrastructure company. They have a number of data centers built around the concept that would find a familiar home with the American and Russian Armies of the Second World War. Instead of buying the best server and storage technology available, Google builds massive server farms using the concept that cheap and numerous is better then a few high-end storage systems. A typical Google server farm ranges from 3000 to 5000 servers (enough to keep it running and support the traffic load) with ethernet switches and routers as necessary. Google believes the value of their network is in the software that ties servers together – not in the hardware itself. They then take this server model and replicate it as required. Each server farm is built on the assumption that a number of servers (~25) can be out of service at any one time without affecting service. To keep cost down, Google buys off the shelf servers from the any of the computer suppliers (e.g. Dell, HPQ, IBM, etc) who are offering the best price. The real cost of a Google datacenter is not in the hardware, but in power. Power is a significant portion of their cost as power is required to operate 5000 servers as well as cool the heat output of 5000 servers. Google thinks a lot about power consumption as seen in their recent paper submitted to the Intel Developers Forum (IDF) [see http://www.nytimes.com/2006/09/26/technology/26google.html].
A few years ago, Google did not have a distributed datacenter architecture and the exogenous shocks of 9/11 and Katrina affected their thinking in terms of network architecture. The increased number of Google data centers as well as need to deploy smaller localized data centers for regional or localized content, has created the need to ensure that there was enough bandwidth and resiliency in their network connections to load level and provide cache updating across a distributed data center network. This is a scaling challenge caused by ever increasing amounts of content and the need to organize, locate as well as educate other Google servers where to find information.
What is important to Google?
Setting aside the three things Google does well, the next most important consideration for Google is the health of the network and the deployment of ever increasing amounts of bandwidth in the global internet. The first five to ten years of the internet have often been called the Web 1.0 or the dialup years. The internet in the mid-1990s looked more like and SNA next from the early 1990s then the basis for a new economy. Post the technology/telecom crash the new internet excitement has centered on Web 2.0 and the deployment of a broadband version of the internet. For the past several years, the service providers have been in the business of upgrading the internet from dialup to broadband. This created a new of challenges which can be covered off in another discussion, but evolution from dialup to broadband is an important health measurement of the overall technology/telecom ecosystem for Google. If Google is maintain a healthy business model, then driving more users (i.e. consumers) to their servers and connecting these users with content and advertisers is the core function of the company.
As content consumes increasing amounts of bandwidth, the speeds, capacities and methods of internet access are an important consideration for Google to monitor. Google has seen massive growth in Google Talk and Google Earth, which are two applications that consume a large amount of bandwidth. This is the reason they are trying to provide the performance and the significantly superior sound quality of Google Talk (i.e. bandwidth) over mobile phones and land lines. [see the recent article on LightReading.com http://www.lightreading.com/document.asp?doc_id=104756&WT.svl=news1_1]
Another area of importance to Google is key alliances with content delivery systems such as AOL. In the war between Google and Microsoft, we can see two companies that are increasingly in conflict with each other and each is coming from a different domain expertise. Microsoft’s domain expertise is the operating system and the applications that run on their operating system. Google expertise is the cataloging the content on the web and users with advertisers through relevant content. If you make the assumption the future OS is network based – not system based as in past ~25 years, then a real paradigm shift is occurring. In this war Google and Microsoft both view service providers of all types (i.e. wireline, mobile, ILEC, CLEC, PTT, RBOC, Cable) as companies that are increasingly overlapping in the their competitive offerings and they are an important connection to ensure is that a relationship exists with these providers to ensure access to the end users. Cleary the moves by Microsoft with its relationship with at&t (formerly SBC) and the handset providers is a concern to Google. Google wants to see the world of devices that are used to access content move away from device centric operating systems, while Microsoft wants to seed more end-user devices (e.g. computers, mobile phones, set top boxes) with a Microsoft OS. It is important to remember that this is not the first time Microsoft has engaged in strategic initiatives in the broader technology ecosystem. The following text is from my book (yes, I know, cheap promotion, but it is easier to cut and paste then type for hour), Six Years that Shook the World, pages 100-103 [see http://www.amazon.com/gp/product/1419634690/ref=pd_rvi_gw_1/104-1068541-9747117?ie=UTF8]:
“In the time period from 1993 to 1994, Microsoft was consumed with readying one of the most significant product launches in the company’s history as well as developing an online service to rival AOL, Compuserve, and Prodigy. The impending new product launch would be a significant driver of Microsoft revenue and would secure Microsoft’s position as the dominant supplier of operating systems for the PC market. This product was called Windows 95 and in August of 1994 when the product was launched, it was difficult to avoid the global marketing campaign developed by Microsoft around the Rolling Stones’ song, Start Me Up. It was just a few short months before the launch of Windows 95, that Microsoft made a commitment to the web. In April of 1994, Bill Gates wrote an important memo to the key leaders of the company entitled, “Sea Change.” In this memo, he outlined the importance of the web and set Microsoft on a rapid development plan to integrate a browser into the Windows 95 product, which was scheduled to launch in a few short months [see Speeding the Net, Joshua Quittner and Michelle Slatalla, 1998]. Before the April memo from Bill Gates, the web was not a top priority for Microsoft and its best resources were not aligned to capitalize on the emergence of the web. Although Microsoft did start work on its browser in late 1993, it was not a top development priority within the company. Following the launch of Windows 95, the MSN Network, and Internet Explorer 1.0, Microsoft began some initial investments in the internet revolution, but the company was still focused on the anticipated revolution in the consumer market of television. As part of their investment in the internet, Microsoft became an investor in UUNET in 1995, but the main investment focus of the company was in area of interactive television. Microsoft envisioned a world in which the personal computer and television would become fused. This belief guided Microsoft to be an early investor in next generation cable television as well as to be a creator of broadcast content. Three significant cable and broadcast media investments set the foundation for what would later become more than $10 billion in follow-on investments in the network infrastructure of cable television to carry high-speed internet data and enhanced video services.
The first major investment that Microsoft made in the cable industry was investing in TCI. The same TCI was the first customer of @Home. Microsoft’s next investment was in a company called WebTV that was developing a form of interactive television. The idea behind WebTV was to provide internet capabilities to a cable television set top box for the consumer who wanted internet access, but did not own a computer. Microsoft eventually acquired WebTV, on April 6, 1997, for $425 million. In the press release announcing the acquisition, Bill Gates said, “This partnership with WebTV underscores our strategy of delivering to consumers the benefits of the Internet together with emerging forms of digital broadcasting.” Before the acquisition of WebTV, Microsoft made a major move into the broadcast media, well before anyone ever envisioned AOL buying Time-Warner. In 1995, Microsoft launched Windows 95 and started a broadcast network with NBC that would become known as MSNBC.
1995 was just the beginning for Microsoft and the cable industry. The next four years would see Microsoft invest nearly $10 billion in the cable industry worldwide. The first big deal announced after 1995, was a $1 billion investment in Comcast in June of 1997. Bill Gates said of the deal, “Our vision for connecting the world of PCs and TVs has long included advanced broadband capabilities to deliver video, data and interactivity to the home. Comcast’s integrated approach to cable distribution, programming and telecommunications complements that vision of linking PCs and TVs. Today’s announcement will enhance the integration of broadband pipes and content to expand the services offered to consumers.” Brian Roberts, then president of Comcast said of the investment, “I am pleased to have Microsoft’s participation as we shape and advance the integration of the PC and the TV. Microsoft’s investment is a strong endorsement of Comcast’s vision to use its cable networks as a broadband vehicle to homes, schools and businesses. Comcast’s customers will be the beneficiaries of the innovations that America’s most advanced computer and cable companies can offer. In addition to a significant cash infusion, this investment gives us access to Microsoft’s expertise, which will help us facilitate the deployment of high-bandwidth applications and lead to more sophisticated services.” Microsoft was making a major play for the interactive television and internet market accessed via cable networks. At the May 1998 NCTA show, Bill Gates said of the internet and cable industry, “By early ’99 we should be rolling out hundreds of thousands, even millions of set-top boxes that combine PC technology with these Internet connections. Now, the information that people will deal with will be in many different places. You’ll have a pocket-sized device that you can take with you. You’ll have your pager or telephone. You’ll have your intelligent set-top box. And you’ll continue to have PCs that you keep in your den, or that you have as portable devices, or that you use at work. Now, through all these devices you’ll want to get at the same information. And the value of having that information online will continue to increase. It’s really stunning, if you go out on the Internet, to see all of the things you can find out there. You can see what’s going on in Congress. In fact, whenever you go and browse a news site, if you’ve provided your zip code, it automatically appends onto any news stories about the Congress, specific information about how your representative voted. There’s even a link that’s included now, where if you disagree with what they did, or if you want to provide feedback, you simply click, and you can provide electronic mail to your representative. And so we’re going to get interactive democracy, letting people participate in new ways. Electronic commerce across the Internet is also exploding. Companies like Amazon.com are achieving very high valuations, as people see the incredible growth there. Whether it’s finding books, finding records, booking travel, all of these things, the interfaces continue to improve. And I think that a substantial part of all of those activities will be done over the Internet. And therefore, give the cable industry a chance to participate, participate in the transaction fees, and participate in owning the companies that are going to make this happen” [see, Bill Gates, http://www.microsoft.com/billgates/speeches/ncta’98.asp%5D.
The one billion dollars invested in Comcast was just the beginning. Microsoft next invested $212.5M in Time-Warner’s Road Runner cable modem service. Time-Warner was one of the few cable service providers that did not use the @Home service, but rather built its own cable modem service. A look at the June 15, 1998 press release finds two typical ITO Revolution quotes from the two Cable Company CEOs involved in the deal. Gerald M. Levin, CEO of Time-Warner said “Today’s investments by Microsoft and Compaq validate the cable architecture as a premier Internet distribution medium, which will benefit consumers nationwide. This combination of world-class companies will enable us to develop a powerful, branded package of content that will become the high-speed online service of choice for our customers. Microsoft’s and Compaq’s expertise complements perfectly the strengths of Time Warner and MediaOne.” Chuck Lillis, who was chairman and CEO of MediaOne said, “With this combination of industry leaders, the venture will be well-positioned to rapidly deploy a wide range of high-value content and services to our customers. As network-based services become ever more integral to our lives, providing a network that will allow us to ensure the performance, connectivity and interoperability to any network in the world will be critical. This venture provides the ideal platform to build both the online service of choice and the network.”
As Microsoft pushed into 1999, their investment in the cable infrastructure as a broadband delivery mechanism increased. Interactive active television, the internet, and the legacy service of telephony became targets for Microsoft money. In January of 1999, Microsoft made a $500 million dollar investment in NTL, the largest cable provider in the United Kingdom. Barclay Knapp, then CEO of NTL said, “Microsoft believes in our vision of bringing advanced digital Internet, telephone and television services to consumers and businesses throughout the UK via all platforms. NTL’s pioneering marketing, network and back-office resources, coupled with Microsoft’s world leadership in personal computing and digital television, will make for a great combination.”
Following the NTL investment, Microsoft made two international cable investments and one of the largest single investments in the company’s history. The two international cable investments were in the cable arm of Portugal Telecom (PT) and Rogers Communications in Canada. The investments were $38.6 million in PT and $400 million in Rogers, which is the largest cable operator in Canada. On July 12, 1999, Microsoft and AT&T announced a $5 billion dollar investment by Microsoft in the cable business of AT&T, known as AT&T Broadband. In the press release, Bill Gates was quoted as saying, “Our agreement today represents an important step in Microsoft’s vision of making the Web lifestyle a reality. Working with AT&T, a leader in the delivery of cable and telephony technologies, we will expand access to an even richer Internet and television experience for millions of people.” In turn, AT&T used the proceeds from this transaction on capital expenditures to improve their cable network. This infusion of capital to build their own network occurred four months after the merger of @Home and Excite.”
Beyond the health of the internet and relationships with content providers, Google looks at broader markets to drive more users to their site. With this in mind, finding successful strategies to commercialize their revenue mechanism in Asia-Pac and Europe is important. Google wants to promote broadband deployments, whether wireline or wireless in large demographic markets for in Asia-Pac. Anytime large demographic populations with increasing disposable wealth have broadband access to the Internet, Google thinks they can make their new age advertising model work.
Where does Google fit?
With Google shares priced at $403 (09.28.06 closing price) they receive a lot of press coverage regarding their share price and valuation. A good example of this coverage can be seen in this entry from the 24/7 Wall St. Blog [see http://247wallst.blogspot.com/2006/09/is-google-200-stock-that-trades-at-400.html]. Google is valued much more highly then Amazon.com, eBay.com and Yahoo.com. Does this mean these companies are not in Google’s peer group or Google is simply a much better company then these peers? I think the answer can be found in two parts. Part 1 is that Google has clearly produced a better mechanism (i.e. engine) to capture advertising revenue. The metric the stock market is seeking is to know the ceiling capacity of Google’s advertising revenue engine? By knowing the peak revenue generating capacity, it will frame the valuation of Google. The second answer is that Google wants to be something else, without disrupting the current business model. They try not to move to far from their core competency, but realize they need to develop a more sophisticated business. I am using the term sophisticated to mean evolving their revenue sources beyond advertising. This then goes back to looking at their strategic relationships with service providers of all types and the development of applications in a network centric computing model and how this paradigm shift (if it occurs) can be monetized to add to their advertising revenue stream or hedge against a decline in advertising revenues. Google is valued today because the stock market does not know the extent to which they can grow their advertising revenues and there is a component in their valuation that accounts for Google being perceived as an important brand and innovator in the next twenty-five year technology paradigm that started when the technology crash bottomed out in 2003.