Googling For Gold
COVER STORY PODCAST
With the news that shares of online search giant Google Inc. (GOOG ) had crossed the lofty $400-per-share mark on Nov. 17, the world may have witnessed something akin to the birth of a new financial planetary system. Given its market cap of $120 billion, double that of its nearest competitor, Yahoo!, Google now has the gravitational pull to draw in a host of institutions and company matchmakers unable to resist the potential profit opportunities. Google stock, with a price-earnings ratio of 70, represents one of the richest dealmaking currencies anywhere. That heft has attracted a growing galaxy of entrepreneurs, venture capitalists, and investment bankers, all of whom are orbiting Google in the hopes of selling it something -- a new service, a startup company, even a new strategy -- anything to get their hands on a little of the Google gold. "The dollars at stake are huge," says Geoffrey Baldwin, managing director at San Francisco investment bank Perseus Group.
The Google effect is already changing the delicate balance in Silicon Valley between venture capitalists and startup companies. Instead of nurturing the most promising startups with an eye toward taking the fledgling businesses public, a growing number of VCs now scour the landscape for anyone with a technology or service that might fill a gap in Google's portfolio. Google itself and not the larger market has become the exit strategy as VCs plan for the day they can take their money out of their startups. Business founders have felt the tug as well. "You're hearing about a lot of entrepreneurs pitching VCs with their end goal to be acquired by Google," says Daniel Primack, editor of PE Week Wire, a dealmaking digest popular in VC circles. "It's a complete 180 [degree turn] from the IPO craze of five years ago; now Google is looked at like NASDAQ was then." Other entrepreneurs, meanwhile, are skipping the VC stage altogether, hoping to sell directly to Google.
On Wall Street, the Google effect, while less profound, is still clearly in force. All manner of investment banks, from giants such as Morgan Stanley (MWD ) and Credit Suisse First Boston (CSB ) to mid-size players such as Allen & Co., have dispatched bankers to Google's Mountain View (Calif.) headquarters, the better to court the Google gatekeepers as they attempt to sell a raft of mergers and acquisitions, financings, and strategic advice. Meanwhile, smaller boutique firms are trying to ride Google's considerable coattails, signing up the scores of increasingly valuable Web upstarts cropping up around Google.
There's one snag in this planetary realignment: Google has shown little interest so far in doing big deals with anyone. Although it briefly sniffed around Web-phone giant Skype Technologies, Google blanched at the eventual price of $2.6 billion ponied up by eBay Inc. (EBAY ) in September. In fact, Google's biggest deal to date is the $102 million it paid for online ad upstart Applied Semantics Inc. in 2003. For now, at least, Google is passing on big, bold deals. "They are flooded with people trying to get in the door," says Rodd Langenhagen, managing director of Boston mergers and acquisitions shop Revolution Partners. "But so far Google is just a great potential acquirer." Adds tech banker Alec Ellison of New York-based Jefferies Broadview: "M&A is just not a very high priority for them."
But if dot-com history is any indication, the risks of doing nothing could be substantial. Google could be sitting on an ephemeral asset. In 1999, Yahoo Inc. (YHOO ), Google's closest publicly traded equivalent, had a $115 billion market cap but passed up the chance to buy eBay. Today, eBay is worth more than Yahoo, whose value has since nearly halved. At its 1999 height, Doubleclick, the big online ad player of yesteryear, had $14 billion in market cap. It didn't put it to work, though, and in April this year was bought by a private equity firm for just over $1 billion.
That's not to say Google could afford to go out and do a big deal just for the sake of it. A mega-takeover potentially could wreak havoc on Google. Even Piper Jaffray Co's. (PJC ) Internet analyst Safa Rashtchy, one of Wall Street's biggest Google bulls, says: "If they were to buy AOL or eBay, it would hurt the stock." Says David C. Drummond, Google's head of corporate development: "We're not going to manufacture opportunities solely because of the currency." (Although Google prefers not to comment on its dealmaking plans, it did make Drummond, as well as its investment bankers, available for some questions.)
All the same, the lure of a big deal could prove hard to resist, particularly if Google's strategic position is threatened. For the past two months, Google has been battling Microsoft Corp. (MSFT ) at the bargaining table for a stake in Time Warner Inc.'s (TWX ) AOL unit, possibly through an expanded partnership or a joint venture. Google has all but owned the AOL relationship since 2002, providing both search technology and ads. AOL has meant big business for Google, accounting for 11% of its $2.6 billion gross revenues in the first half of this year. But perhaps more compelling to Google is AOL's access to reams of content owned by sister companies such as Time Inc. and cable channel HBO.
The negotiations are taking Google into uncharted territory. Some analysts value AOL's business as high as $20 billion, including about $12 billion for the coveted portal and search pieces. The search kingpin could prevail with an expanded partnership and shell out virtually nothing. But the fact that Google is still at the high-stakes table shows how much it could lose if AOL walks.
Such strategic contingencies weren't mapped out in the coy statements made in Google's prospectus when it first sold shares to the public 15 months ago. "We would fund projects that have a 10% chance of earning a billion dollars over the long term," wrote founders Sergey Brin and Larry Page. And then they added: "Do not be surprised if we place smaller bets in areas that seem very speculative or even strange. As the ratio of reward to risk increases, we will accept projects further outside our normal areas, especially when the initial investment is small." That's enough to give hope but not much direction to would-be partners and dealmakers.
Rainmakers at blue-chip investment banks are accustomed to a certain level of respect -- something that Google is unwilling to grant automatically. Just ask Goldman, Sachs & Co. (GS ) Goldman famously got the boot from the elite group selected to manage Google's IPO after Brin and Page caught wind of the firm's backroom lobbying of one of Google's largest VCs for a bigger stake in the deal. The bank has been trying to crawl out of the woodshed ever since. Goldman declined to comment.
"The First Inning"
In fact, Brin and Page have made a sport of snubbing Wall Street since they co-founded the company in 1998. They've made it clear that Google plays by its own rules and values. Their August, 2004, IPO filing reads more like a manifesto than the usual drab financial boilerplate. And by masterminding the IPO as a modified Dutch auction, they thumbed their noses at Wall Street's traditional trust-us-and-we'll-handle-everything way of doing business.
Still, many bankers believe that in the new Google-centric universe, immense profits are to be made, even if Google itself remains tightfisted. "This is an investment banking gold rush," says Perseus' Baldwin, as he whips out a glossy pitch book and points to statistics illustrating massive changes in the world of advertising and media. Those trends may be led by Google, but they imply some wrenching tectonic shifts throughout the media world. And in those dislocations lies opportunity for astute investors and dealmakers.
Last year U.S. advertising spending was an estimated $300 billion to $400 billion. Just $10 billion of that was spent online, even less than for ads in the Yellow Pages. By contrast, newspaper and direct telephone markets were worth five and nine times as much, respectively. Yet, according to Forrester Research Inc., households now spend at least 30% of their media time online, while the Internet has just 5% of total ad spending. That situation won't last for long. According to the Interactive Advertising Bureau and PricewaterhouseCoopers, online ad revenue grew 34% in the latest quarter, with total 2005 revenue on track to grow by 25%, to at least $12 billion; newspaper ad revenue, by contrast, is slated to grow less than 3% this year. Baldwin says that Perseus has a backlog of six portal and e-marketing transactions poised to benefit from this revenue reallocation in Google's wake, and is on pace to complete at least 30 deals in 2005, twice last year's tally.
Google's own bankers have also seen the possibilities lurking in the company's $120 billion shadow. "You almost bank on other companies becoming successful because of Google," says banker Quincy Smith of Allen & Co., which represents Google. He points to Advertising.com, an e-marketing client that appeared on his radar when he noticed that 40% of its revenue came through Google. Allen & Co. helped sell the company to AOL for $435 million in June, 2004 -- demonstrating how even a dormant Google made the bank money. Another major Google banker hammered home the 5% online ad market share figure in a presentation to institutional shareholders interested in Google's $4.2 billion secondary share offering on Sept. 16: "I told them, 'Oh my God, we're just in the first inning. Advertising will be completely turned on its ear."'
In the Silicon Valley food chain, the first to lay bets on which way things will shake out are the venture capitalists whose fate is now firmly entwined with that of Google. It's not a very comfortable position for VCs, who view Google with a mixture of disdain and envy. Googlers, as they're known -- many of whom have emerged from their company's remarkable increase in value with sizable personal fortunes -- work in one of the cushiest corporate campuses in the Valley. There's the free cafeteria that was started by Google's millionaire former chef, who used to work for Jerry Garcia of the Grateful Dead, as well as facilities for volleyball, foosball, and rollerblading. After their workouts, Googlers can snack in a stocked pantry or enjoy an on-site massage. Young Googlers' preoccupation with these perks tend to drive mature VCs to distraction. "If I hear one more [punk] complain about his omelet, or tell me he's bored with the smoothie selection, I'm gonna, I don't know," splutters one.
Of course, such luxuries aren't the real problem. It's what the VCs perceive as arrogance and a lack of respect for the role they play. VCs, after all, have at some point identified, believed in, nurtured, and funded -- not to mention made huge profits from -- the biggest names in techdom, from eBay to Cisco Systems and Google itself. Yet many feel that Google accords them roughly the same respect as it does vendors bidding on the groundskeeping contract.
Many VCs, for example are still fuming over the "Google Startup Day." VCs, who are used to making elaborate and proprietary pitches to potential investors, were instead summoned as a group to take turns making their spiels to Google's 10-person corporate development group. "Check out the gall," says one, sharing an Aug. 3 e-mail from Google's in-house M&A team. "Hi Very Senior Partner," the mass memo says by way of salutation. After explaining the hoops through which the VCs would have to jump to go to Startup Day, it asks those interested to "please fill in the attached spreadsheet with a brief description of each company and its business/technology, an overview of the team, any data points you would like to share, and a perspective of why the company might work with Google." Says the aggrieved VC: "Did it ever occur to them that this was like asking us to do their homework for them? It's the height of arrogance." Not so, responds Google's Drummond: "This was an attempt at outreach," he says. "Most VCs do like to talk to us. Google is very much involved in the venture community -- a lot more than people understand."
All the same, two Google insiders privately groused to BusinessWeek about the stunt. These companies would be foolish to cough up their trade secrets to Google, they contend, while the search giant offers little information in return.
Although Startup Day never happened, Google said it did subsequently meet with individual VCs. As Credit Suisse First Boston's George Boutros, a lead Google banker, says: "If Google wants access to the venture community, Google gets access to the venture community."
VCs have another more concrete reason to resent Google: With its deep pockets and its unwillingness to give quarter to outside professionals, it's now a growing competitor to Valley VCs. Google can easily afford to swoop in and outbid any VC for a startup, particularly if Brin and Page truly mean they would be happy with a 1-in-10 chance of an investment paying off big. That's encouraging entrepreneurs to "bootstrap it" -- go it alone, lean, mean, and cheap, without the help of expensive VCs, in the hopes of pocketing a bigger share of the proceeds of a sale to Google. For example, Google bought both Blogger.com parent Pyra Labs and wireless player Android Inc. directly from their founders. According to people familiar with the deal, the Android buyout was essentially a bet on the company's star-studded cast, including engineering whiz Andy Rubin, who previously had founded handset maker Danger Inc. Co-founder Page, the sources say, put the acquisition on the fast track.
Indeed, Google strongly prefers to gobble up startups before they have embarked on a sales and marketing strategy, viewing companies that are completely tech-focused as a better cultural fit. It prefers to acquire small, local technology teams that it can simply plug into its headquarters. "Two guys in a garage with nose rings and a dog trying to catch lightning in a bottle" is how banker Smith characterizes the bias. Case in point: Last year Google snapped up Keyhole, a digital mapping company based next door in Mountain View, for an undisclosed sum. Its team moved down the road and within six months, Keyhole was providing the satellite technology behind Google's celebrated mapping tool. Conversely, Google has passed on larger, out-of-town deals, in large part because of integration worries.
Google is creating a whole new ecosystem for entrepreneurs, says Baris Karadogan of U.S. Venture Partners, a high-tech VC firm in Silicon Valley. Karadogan says he's closely watching a group of entrepreneurs who are designing a highly specialized online advertising tool, hoping to sell it to Google for $50 million. "Before," he laments, "you needed a VC. Now you can build a Linux-based data system for $100,000 and survive long enough to sell without ever raising a venture round."
The suits inside Google don't fare much better than the outside pros. Several current and former insiders say there's a caste system, in which business types are second-class citizens to Google's valued code jockeys. They argue that it could prove to be a big challenge in the future as Google seeks to maintain its growth. They deem the corporate development team as underpowered in the company, with engineers and product managers tending to carry more clout than salesmen and dealmakers.
A banker who interviewed for a Google corporate development job came to a similar conclusion. "They just aren't very focused," says the prospective hire, who didn't get the job. "They're biased against businesspeople, and their deal strategy is pretty much, 'O.K., if we see something, then we'll look at it."' The candidate, a Wall Street tech M&A specialist who was looking for a change of scenery and a more relaxed lifestyle, calls the experience "chaotic, bureaucratic, and very rigid." Strung out over more than nine months and numerous coast-to-coast flights, the courtship culminated in a jarring "pop quiz." The corporate development team suddenly broke from the script and gave the banker a laptop and 40 minutes to value a business, suggest a strategic buyer, and present a case to the entire team.
Drummond rejects the accusations that Google is anti-businesspeople. He says Google has hired many MBAs and bankers and is constantly assessing its dealmaking strategy. "At some point," he adds, "it might make sense for us to be [acquisitive] like a Cisco or GE."
Apparently, that time has not yet come. Surprisingly for a company of Google's size, clout, and business needs, it doesn't yet have a thriving in-house VC arm. And that's despite some glaring holes in its product lineup. "We're clearly not going to do everything right," concedes Drummond. "There are areas we miss that others will fill out." For starters, Google has a long way to go to match the breadth, depth, and richness of Yahoo's portal. Ditto a peer-to-peer marketplace along the lines of an eBay, as well as Microsoft-like software applications.
Despite the hurdles they face, don't expect any of the legions of investment bankers, VCs, or entrepreneurs to fold their tents and go home. The stakes are too big, and everyone wants in. To steal a note from the Google home page: Feeling lucky?
By Roben Farzad and Ben Elgin, with Catherine Yang in Washington
— With assistance by Catherine Yang