Valuing Google
© James Dow, 2009
revised 2011, 2013
Do not distribute without permission
1996: Stanford
Sergey Brin and Larry Page are PhD students in
computer science at Stanford University. They
are working on a project to develop a better
search engine.
Initial Funding
In 1998, Andy Bechtolsheim, co-founder of
Sun, gives them a check for $100,000.
They incorporate in September 1998.
1999: $25 million from Sequoia Capital and
Kleiner, Perkins, Caufield and Byers.
2004: An IPO is Announced
Set for August 2004
Dutch Auction:
Investors submit bids
Bids are ordered, price sets supply =
demand
All investors get the same price
April 2004: S1 filing with SEC
1999
2000
2001
2002
2003
2004Q1
Revenue
220
19,108
86,426
347,848
961,874
389,638
Income
(6,076)
(14,690)
6,985
99,656
105,648
63,973
Per share
(0.14)
(0.22)
0.07
0.86
0.77
0.42
Diluted
(0.14)
(0.22)
0.04
0.45
0.41
0.24
How to forecast the rest of 2004?
2003
2003Q1
2004Q1
Revenues
961,874
178,894
389,638
Income
105,648
25,800
63,973
Per Share
0.77
0.20
0.42
Diluted
0.41
0.10
0.24
(2004Q1) x (4)
(2004Q1) x (2003)
(2003Q1)
Actual
2004
2004
2004
1,558,552
2,094,998
3,189,223
255,892
261,962
839,553
1.68
1.62
2.07
0.96
0.98
1.46
Google vs. Yahoo
Google
2000
2001
2002
2003
2004 (actual)
Revenue
19,108
86,426
439,508
1,465,934
3,189,223
Net Income
(14,690)
6,985
99,656
105,648
399,119
Per Share(d) (0.22)
0.04
0.45
0.41
1.46
Yahoo
2000
2001
2002
2003
2004 (actual)
Revenue
1,110,178
717,422
953,067
1,625.097
3,574,517
Net Income
70,776
(92,788)
42,815
237,879
839,553
(0.08)
0.04
0.18
0.58
Per Share(d) 0.06
How do they compare in terms of revenue?
How do they compare in terms of profitability?
Pricing Google with P/E Ratios
Assume Google is just like Yahoo in 2004
Yahoo shares sold for around $30
Yahoo earned $0.58 per share
This gives a P/E ratio of 52
$30/$0.58 = 52
Apply this to Google’s earnings of $1.46 per share.
Google should trade for $76
$1.46 x 52 = $76
What if we knew 2005?
Google earnings = $5.02 per share
Yahoo P/E (2004 price to 2005 earnings) = 24
At 24, Google price = $120
$5.02 x 24 = $120
At 52, Google price = $261
$5.02 x 52 = $261
What should you bid?
$76 based on 2004 information?
$120-$261 based on 2005 information?
Google’s “guidance” of $108-$135?
August 2004: The Actual IPO
Our estimates range from $76 to $261.
And the auction price is:
$85
The next day the price jumps to $104.
It reaches $198 by the end of the year.
What happened after 2004?
Google
Yahoo
2004
256%
222%
2005
243%
121%
2006
98%
-22%
2007
38%
-8%
2008
0%
-38%
2009
53%
45%
2010
29%
114%
2011
13%
-10%
2012
9%
In 2008, Yahoo turned down an offer to be
bought out by Microsoft and its continued
existence as an independent firm is
questionable.
Google in 2011 was one of the ten largest
companies in the US by market
capitalization.
Discounted Cash Flow
Why discounted cash flow?
Earnings do not grow at a constant rate.
Google earnings grew 256% in 2004
34% in 2007
Using multiples assumes that other stocks are
priced correctly.
The price of Yahoo fell in 2005 despite
earnings more than doubling.
How to do it
Step 1: Estimate the cash flow for each year.
At some point, assume constant growth.
Step 2: Determine the appropriate discount rate.
Step 3: Discount the cash flows and add them
up.
Step 1: Estimate the cash flows
Business Week, 2004
Actual
Year
FCF Growth
Year
EPS(d) Growth
2005
100%+
2005
243
2006
100%+
2006
98
2007
100%+
2007
38
2008
~90%
2008
0
2009
~70%
2009
53%
2010
~55%
2010
29%
2011
~44%
2011
13%
2012-2018
Down to
Below 10%
2012
9%
2019 on
3%
Slight of Hand
Earnings > FCF > Dividends
In long run they should grow together
Not so much at the start
FCF hard for us to calculate
Handling the terminal value
Pick a growth rate (5%, 3%)
Value as a perpetuity
Discount to the present
Step 2: The Discount Rate
Base rate + risk premium
CAPM and Beta
BW: Beta of 2 and discount rate of 17.4%
Later, others use discount rates as low as 10%
Step 3. Present Value
E0=
R=
g=
1.46
0.174
0.05
Year
2004
Growth
Earnings
109.97
2005
1
243
5.01
4.27
2006
2
98
9.92
7.19
2007
3
34
13.29
8.21
2008
4
21
16.08
8.46
2009
5
15
18.49
8.29
2010
6
10
20.34
7.77
2011
7
5
21.35
6.95
2012
8
5
22.42
6.21
2013
9
5
23.54
5.56
2014
10
5
24.72 Terminal Value
4.97 42.09
Sensitivity Analysis
Base price = $110
g = 0.03: price = $103
R = 0.15: price = $140
R = 0.10: price = $298
How do the values compare?
Actual price:
$85 - $198
P/E estimates: $76-$261
DCF estimates: $103-$298
Warning
These are ballpark estimates.
If doing this for real you should be much more
careful with the data.