Valuing Google James Dow, 2009 revised 2011, 2013

Valuing Google  James Dow, 2009 revised 2011, 2013

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? Revenues Income Per Share Diluted (2004Q1) x (4) 2003 961,874 105,648 0.77 0.41 2003Q1 178,894 25,800 0.20 0.10 (2004Q1) x (2003) (2003Q1) 2004Q1

389,638 63,973 0.42 0.24 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 Googles 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? Googles 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% 2012-2018

Down to Below 10% 3% 2011 13% 2012 9% 2019 on 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.

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