A year ago to the day, prominent Internet analyst Safa Rashtchy drew headlines and wonder by predicting Google would hit $600 a share in 2006. That wasn't exactly the case, as the Mountain View (Calif.) company rose about 6% to close the year at $460.48. Now, in what's becoming an annual tradition, on Jan. 3 Rashtchy has again hiked his target on Google (GOOG), this time to $630 per share.
Rashtchy of Piper Jaffray says his target price hasn't seen reality yet because of the sector, not Google. "There was rotation away from the Internet," he says. "That was largely the reason there was less interest in all these stocks."
"A Virtuous Cycle"
He still believes the company's revenue will continue growing, thanks to expansion efforts such as Gmail, the company's free Web-based e-mail, and the map service Google Maps. He says those products will draw more users to Google and make its brand more meaningful beyond its core business as an Internet search engine. Piper Jaffray (PJC) which has done investment banking work for Google in the past year, recently surveyed 337 Internet users, in which it found that 49% of respondents use at least one Google product aside from search. A quarter used at least two.
"While Google's partnership strategy and monetization improvement trajectory are well understood by investors, we do not believe investors fully understand the impact of Google's non-search related product extension strategy," Rashtchy wrote Jan. 3 in a note to clients. As a result, "consumer adoption of non-search-related products creates a virtuous cycle of brand affinity that drives incremental search volume." In other words, the more you use Gmail, share photos with Picasa, or get directions to a new club with Google Maps, the more likely you are to feel good about Google's free services—and, by using them, eventually drive more cash to the company.
Another trend Piper Jaffray sees: search becoming a more important component of Web surfing. Whereas people once used a search engine for research or to locate a business, such sites are now becoming "the dominant navigation method"—that is, essentially used as a browser—by many, according to the brokerage's survey.
To arrive at his new price target, Rashtchy is betting that Google will grow by 35 times his 2008 pro forma earnings per share estimate of $18.06, instead of the 43 times growth multiple he used previously. He explained his decision by mentioning things like the limited visibility of the nearly 24-month time frame and the increasingly large scale of Google's business.
Rashtchy is more optimistic than most. His estimate on Google's earnings for 2008 amounts to $16.59 per share. The mean analyst estimate amounted to $13.75 per share, according to the San Francisco research firm StarMine, which aggregates data from Thomson Financial (TOC).
The stock reached a 52-week high of $513 just before Thanksgiving and pulled back by year's end. And $630 isn't even the loftiest Google target out there. Derek Brown, an equity analyst at Cantor Fitzgerald, opened coverage of the stock in December, 2006, with a $650 price target. Brown figures a multiple of 35 to 40 times price to pro forma earnings per share is justified given a three-year revenue growth rate of 40%, "long-term industry dynamics, and comparable company valuations."
"We fully recognize that the party at Google has to end sometime," Brown wrote in a Dec. 21 research note. "Yet, we see no obvious signs that Google's business has hit the proverbial wall or that consumers and advertisers are radically shifting their behavior away from Google and toward its competitors."
A year ago, Rashtchy's confident call mobilized Google's boosters, elevating the shares 5%, to $434, by the close of trading that day (see BusinessWeek.com, 1/4/06, "Google: $600 or Bust?"). Rashtchy's call this year didn't pack quite the same punch in the market as it did in 2006. Google's stock closed on Jan. 3 near $467.59 on the Nasdaq, up 1.5% compared with the previous session's close.
Bear in the Wilderness?
Rich Summer, an analyst at the research firm Morningstar (MORN), calls himself "a lone bear" on Google. He thinks the shares are fairly valued at $315 apiece, noting that nearly all Google's revenue comes from online advertising. As far as he's concerned, that means Google hasn't yet created any business outside search that has spurred new growth beyond advertising.
Summer also points out that Google has been growing more slowly in recent years. He forecasts that the company's revenue increased by only around 70% in 2006, compared with 90% in 2005, just over 100% in 2004, more than 200% in 2003, and 400% in 2002.
Meanwhile, Google has been spending substantial amounts of its huge cash horde recently on building up areas such as its server capacity and data farms. The company paid out $1.5 billion on capital expenditures in 2006, Summer estimates, compared with only $300 million in 2004. And he's not sure how much new cash those investments will attract in the future.
"The company has remarkable growth ahead," Summer says. "But the price reflects that—as well as a bunch of pipe dreams."