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Google's IPO: Asking Too Much?

By Ben Elgin Audacity has never been in short supply at Google. After revolutionizing Internet searches and revitalizing Web-based e-mail by promising free, mammoth-size accounts, Google thumbed its nose at Wall Street's fat cats and demanded an auction to equitably sell shares in its upcoming public offering. Now, Google is at it again, on July 26 setting a ballpark price for the stock that some experts deem a stretch.

Google says its 26.4 million shares will likely cost between $108 and $135 apiece, according to a pre-IPO filing with the Securities & Exchange Commission. That would put Google's valuation between $29 billion and $36 billion, just shy of the $38 billion market cap of competitor Yahoo! (YHOO). Taking the midpoint of Google's valuation range, the search giant would be trading at 40 times 2005 earnings, vs. 42 times earnings for Yahoo, according to projections by Susquehanna Financial Group analyst Marianne Wolk.

That's not much of discount for would-be investors worried about a potentially volatile IPO in an uncertain market or, for that matter, the lack of diversity in Google's revenues. Nor does it reflect other hiccups, like the July 26 virus that hammered several sites, including Google, shutting off access to many users. "It's priced for ultimate perfection," says one Google investor, who plans on selling quickly after the offering.

SIGHT AND SOUND. Critics have a legitimate concern. Sure, Google's numbers for its second quarter, which ended June 30, were impressive. Sales jumped 125%, to $700 million, while net profits soared 146%, to $79 million. But Google is still largely a one-trick pony. Ads appearing next to search results accounted for about three-quarters of its business last year. Although this has been a red-hot market, it's also starting to mature. The so-called paid search market grew 220% worldwide in 2003, according to analyst data compiled by Yahoo. That's expected to slow to 59% growth this year, 33% in 2005, and 22% in 2006.

Yahoo, although weaker than Google in search, boasts a more diverse business, with revenues from the likes of Internet access partnerships, fantasy sports, and "branded" ads that appear outside of the search property, says Susquehanna's Wolk: "We would expect Google would trade at a discount to Yahoo."

Diversifying into branded ads could be the pivotal challenge for Google. Typically flashier and sometimes featuring audio and video, these ads are particularly attractive to marketers who want to build brand as well as drive traffic to their sites. The offspring of the staid banner ads of yore, such display ads are big business -- expected to reach $4.5 billion in the U.S. this year, vs. $2.8 billion for search ads, according to Forrester Research.

And although search ads are growing faster, many analysts have been surprised at the recent surge in branded ads, which Forrester expects to climb 16% this year. "That's a huge amount of growth," says Forrester analyst Charlene Li.

CHANGE OF DIRECTION. Google isn't conceding this market. It's currently testing an offering that lets advertisers display visual ads on partner sites. This is a big leap for Google, which has carved out a reputation for delivering unobtrusive ads with a focus on fast-loading pages. Obviously, such a move has the potential to whet the appetites of brand-centric marketers.

Eventually, it's quite possible that Google will experiment with image-based ads next to its own search results. Although this would certainly bother die-hard users, many advertisers would welcome it. "Absolutely, advertisers would be interested," says Jeff Lanctot, vice-president for media at online agency Avenue A. "But Google would have to think a lot about it. It would be so contrary to the approach they've always taken."

Google wouldn't comment about such possibilities, citing its pre-IPO quiet period. But with the outfit anticipating such a nosebleed price tag, the smart money says it'll need to diversify its business -- and fast. Elgin is a correspondent in BusinessWeek's Silicon Valley bureau

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