Saturday, October 21, 2006

Google's Continuing March Forward

“We believe the company is rapidly becoming the digital advertising agency for every company in the world.” --Stifel Nicolaus & Co. analyst Scott Devitt

Google's market capitalization ($143 B as of Friday, October 20th) continues to blow by various old media, software, and computer hardware companies. Is the valuation justified? There does seem to be a bit of the extrapolation-driven valuation going on--the same methodologies that drove up the prices of Enron and Global Crossing in the late 1990s. However, the difference is that Google's business model is actually simple, understandable, and makes money. There are three big questions that dog Google today and basically form the "beta" around the stock's current meteoric rise.

1. Barriers to Entry. I don't think there's any question that if Google can grab up 40-50% of the online advertising and media game over the long-run, the current valuation is actually pretty conservative. However, what is preventing others from joining the party? This is really the YouTube question. Sure, YouTube has the lion's share of Internet video today, but there is really nothing behind it. It would take a Microsoft a couple months to throw together a competitor--wouldn't it? Google needs to get barriers to entry up fast, and I still think it's an open question if barriers to entry are even possible in an open-standard Internet.

2. SEC Action. Uh, remember when Microsoft had all of the OS share and was using it to sell Office, Media Player, etc. etc.? We're not there yet, but I have to think that the SEC's lawyers have a list somewhere in Washington and Google is on it. The difference is that so far they haven't done anything anti-competitive, but at this rate, they will be a Monopoly over multiple forms of digital media, and it'll be harder and harder for them to argue that they're not stifling competition and innovation. Google needs to figure out how to grow smart, leaving just enough competitive pressure out there to avoid a costly SEC investigation. Was it just coincidence that Microsoft's transitition from growth stock to mature stock happened just when the SEC investigation reached its peak?

3. Transition to Old Line Media. Google has publicly stated that they want to move into TV, radio, print, etc.--essentially optimizing media for its clients across both online and offline channels. Why? Is this the first sign of a company losing its focus? This strategy could dilute Google's strategy and definitely could turn into a boondoggle. The reason is simple--you can't write code to track the effectiveness of offline media, and there are about 10,000 companies creating, buying and measuring offline media today. It's true that Google's smart people could be scary here, but isn't there a lot more room to grow online?

So will Google see a real competitor emerge in its core search and online advertising business? Will the company start down the dark path towards anti-trust? Will their non-core business forays distract what has been an extremely deliberate and effective growth strategy thus far? We'll see. I'll revisit the topic in a year and we'll see how they're doing.

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