Tuesday, February 5, 2008

Google Longs got Lucky

The mighty Google has now fallen about 30% from its November high; the last time shares trade below $500 was a full six months ago. The most recent 10% of that decline has occurred in the past week, as the bombs keep dropping on Google. These losses certainly are nothing to sneeze at (and I sympathize for investors who bought in at $730 on the heels of a Cramer recommendation), but the losses really should be even more significant.

Let's look at the news that's dropped in the past week. First, when Google reported its earnings, they missed both top-line and bottom-line estimates (though, admittedly, I think big movements after a 1% disappointment [which is how much Google missed buy on the EPS] are illogical). However, when a stock is priced for near-perfection (as Google certainly was a $750, and to some degree, still was/is), the most minor disappointment can be devastating. (Usually, Google beats and raises estimates.) So after the earnings miss, the stock did drop about 8% after-hours, but even that was relatively minor compared to recent collapses like Apple and VMWare after their disappointments.

Then, the bad news kept coming. After the earnings disappointment, Jefferies & Company downgraded the stock (from buy to hold) and reduced their price target from $725 to $600 (All of this information taken from here, a AP press release found on Yahoo! Finance). "Meanwhile, Citi Investment Research analyst Mark S. Mahaney cut his Google price target to $650 from $775, while RBC Capital Markets analyst Jordan Rohan lowered his target to $675 from $725" (AP press release). One downgrade and two additional price-target drops should have kept Google falling.

Lastly, the news about the Yahoo/Microsoft merger should have been the proverbial straw that broke the search engine's back. If the deal goes through, Google will finally have a serious competitor. With Yahoo having the largest pool of email users and Microsoft providing most of the world with operating system and office software, the companies' strengths should compliment each other well. Google has been trying to break into these areas with Google Apps, Docs, and Spreadsheets, but has failed to displace any significant amount of Microsoft users.

Maybe Yahoo's board or shareholders will reject the offer, or some suitor (many analysts have speculated Newscorp could be one) may come along and bid higher. However, if Microsoft's offer is approved, I don't see antitrust courts blocking the merger. Google controls over 65% of the domestic search market, and leads throughout most of the rest of the world too. Though the vertical integration (operating system -> office suite software -> browser -> search engine) may be scrutinized, I don't think Google's lobbyists (yes, they have lobbyists) will successfully prevent a merger.

So back to my original point - Google has lost $50 in share value since the earnings news dropped. Many Google longs now flaunt Google as a "deep-value" now that it's at $500. But considering the deluge of bad news that's been released in the past week, I wouldn't be surprised if GOOG was currently $100 cheaper.

Don't get me wrong; Google is one of the most incredible, breakthrough-creating companies of the past decade (and will lead the way in the future). But as it becomes mature, it's valuation is looking too rich. Intel and Cisco trade at 13 times forward earnings, while Google is still at over 20 (and one could easily argue that those estimates may not be met). As Google enjoys its domain as a large company, it may have to start trading like one too.

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