Ever since I read about beginning of Google in the book “In the Plex” by Steve Levy, I have been huge fan of its operating model. The mindset of being the best and then develop products that gives you wide moat over industry peers is amazing. In this blog, I want to share my views and fair price for Google’s enterprise value. I have used statistical model to predict growth in different revenue segments and discounted cash flow model to predict the fair price of the stock. I have used criterion of revenue growth and economic moat to develop the case for its fair value.
Revenue growth: For the purpose of this analysis I will divide the revenue growth into three categories of advertisements (Google and YouTube), cloud and other business segments (Waymo, Deepmind etc). Below table list the revenue growth for years 2018 and 2019.
Advertisements: Google generates 83% of its revenue from advertisements. (For the purpose of this analysis I have combined Google and YouTube ads as one category). Googles advertisement business has seen 20% growth on average over the last 4 years. For two quarters in 2020, the revenue from advertisements have remained flat compared to 2019. I am assuming google will remain flat through out the year due to COVID related reduction in spending from corporate. For predicting the future revenues in advertisement section, I have used mathematical models to predict the market size of digital advertisement industry based on its past trends and growth. Considering increasing pressure from Facebook, Amazon and other market entrants in the advertisement market I am predicting the market share of Google will fall to ~30% by 2031. Below table summarizes the predicted revenue growth in advertisement section of business.
Supporting analysis: Other factors considered that may affect the advertisement business are internet usage and growth in spending in digital ads market space. Internet usage growth by region are shown below in the chart. I have used linear regression to compute future predicted growth in internet usage. My model predicts the global internet usage will increase at CAGR of 2%. This means that by 2031 around 70% of world population will be using internet as a service compared to 51% now. Further, on average a normal human being in US spends around 6.3 hours per day on digital media via laptop/computer, mobile and other connect devices. This data when looked together with the technology adoption rate by households which has more than doubled in the last decade, helps to predict the growth in digital ad market. My model told a similar story as well, results indicate a direct co-relation between paid per clicks usage (Google data from 10k filing to sec) and time people spend on internet. My data shows every 10 min increase in time spend on internet results in 8% more ad clicks.
Cloud: One big category where google started with Lackluster strategy and is a late entrant in the market is Cloud. Over the last three (2017 to 2019) the company has grown revenues by 120% in this business segment to around $9B. Cloud industry is already crowded with big players like Amazon and Microsoft, Google might have missed on a golden opportunity by being late but can still grow in double digits in the years to come. Currently, Google has around 6% of the market compared with 31% for Amazon and 20% for Microsoft. According to Gartner, cloud market is supposed to grow at a staggering rate of 55-60% in the next 5 years.
With a lot potential still available in this market, I am projecting the following growth model for Cloud business for google.
Other Business Segments: In other revenue segment, Google has placed high bets on Waymo (self driving car operations), Calico, Verily and Capital G. I expect Google to not make any significant profit from Waymo in the next 7-10 years. But I do expect this technology to evolve and potentially generate billions of dollars in revenue in the next 10-15 year. Similarly, Other significant bets may turn into a winning but it is very difficult to predict. However, on an optimistic note of generating positive revenues I am anticipating a CAGR of 7.3% for the 10 few years from services like Nest, Verily, Deepmind and Google Fiber.
Economic Moat
Advertisement business – Google has a high economic moat in the advertisement business. Its proprietary tools such as AdMob, AdSense and Ad Manager work on principle of paid clicks which gives sponsors a sense of security of paying only when user visits the website. Although google is seeing increase in the number of paid clicks there is certainly a decline in cost per click. Reduction is corporate spending on advertisements couple with pressure from Facebook and Amazon, Google may loose some market share. However, Strong goodwill and the tag line “Google it” will continue to prove very profitable. Even, with tough circumstances no one can take away the fact that advertisements will remain a revenue generating machine of Google. With this I assign this category a high moat market
Cloud business – Google is competing in a tough market space with established players like Amazon and Microsoft. With only 6% market share and no competitive edge over existing players, I assign this category a low moat.
Google others business could prove to be groundbreaking, but none of them have shown a potential for substantial growth. Waymo is completing against Tesla and healthcare market (Verily and Calico) segment is crowded as well. With pending approval for FITBIT, I provide a low moat to Google in this category as well.
Based on the above criteria my model predicts the fair value price of google at $1848. This is 22.5% premium over its current market price of $1508. I expect the operating margin to be around 15-16% and the company will continue to generate growth from ever strong advertisement business. I expect the cost of revenue will continue to increase at steady pace due to higher traffic acquisition cost. I have also assumed a steady tax rate of 20% which is 4% more than current tax rate for Google.
Disclosure: I have a long position in GOOG, GOOGL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
