Google is about to issue 14 159 265 more shares (the number chosen is derived from the decimal expansion of pi) aiming to raise about $4 billion at an average price of about $250 a share. Given that I argued that Google was overvalued at the initial offer price of around $80, it might be time to take another look, both at Google as an investment and at the issues raised by its position in the Internet. In this post, I’ll stick to the first issue.
First, up I should concede that I underestimated Google’s starting level of profits (which wasn’t public before the IPO) and also the rate at which it could increase profits in the short term. Google looks like a better investment than I suggested (though I still think $80, let alone $250 is too high).
On the other hand, the problems with Google’s core business have, I think, become more apparent over the last year or so. Last year I made the point that “there’s no strong reason to suppose that Google will be around in, say, 20 years time,” but this was based more on general principles than on observation of any particular threat to Google’s dominance.
Now, however, I find myself using Google less and alternative methods of finding information on the Internet more. For the kind of search where you simply want to find out a specific fact (such as “when was Gough Whitlam first elected to Parliament”) it’s more efficient to go to Wikipedia. In any case, it is increasingly true that Google searches of this kind will point to Wikipedia, so you might as well go there directly.
The rise of blogs also makes a big difference. For current information, the main Google search engine is pretty much useless. Google News is good for mainstream media sites, but, since blogs have better coverage of many issues, it’s often more effective to use Blogpulse or Technorati.
Finally, and most significantly, there’s RSS. Rather than searching around a range of websites, I can identify in advance the places that are likely to have interesting new stuff, and scan them rapidly in an aggregator like NetNewsWire.
These things are probably not much of a problem for Google in the short run. The number of users moving to Google from older portal sites is probably greater than those moving away from Google to RSS and similar (Eszter has a lot of research on how people find things, and Google is less ubiquitous than you might thing). Nevertheless, there is a fundamental problem in the long run. Ever since the Web began, there have been two alternative ways of finding things. One has relied on known structures and metadata explicitly included in web pages – call this the “conscious design” model. The other has been the “search engine” model of indexing everything and making inferences about structure from links.
The conscious design model was dominant early on. People found things by following links. Yahoo and others made efforts at a hierarchical classification of the entire web. But as the Internet grew and changed at incredible speed during the 1990s, this approach broke down. At the same time, technical innovations yielded improvements in web crawling so that search engines became much more efficient and up to date. In addition, the first attempt at using metadata was rendered useless by spammers. The stage was set for Google, which had a much better algorithm than any of its predecessors, and was also careful not to alienate users by such practices as selling high rankings.
It seems now that the wheel is turning again. Things like tags and RSS feeds are bringing us closer to what’s been called the Semantic Web. This opens up the possibility of using known structure to get information, rather than seeking random matches for search phrases. In these circumstances, Google searches become a backstop, to be used when other methods fail, rather than a first port of call.
Blogs are already pretty much like this. If I want to find out what blogs have to say on topic X, I will do a bunch of different things, including scanning my RSS feeds, putting tags into Blogpulse and Technorati or looking for trackbacks to existing post. Typing X+blog into Google is one option, but not my first preference.
As far as revenue goes, what really matters is searches relating to goods and services. At this stage, there’s not much in the way of useful metadata here. But that’s not surprising. The corporate sector has consistently been a follower rather than a leader in the development of the Internet. Once bloggers and wikipedians have blazed the trail, online merchants will follow sooner or later.
Of course, Google can see all of this. It seems likely that the money being raised now will be used to fund acquisitions like the earlier purchase of Blogger. But it’s harder to see how a revenue model can be built around things like RSS. It seems unlikely that people will subscribe to RSS feeds that include ads, and therefore unlikely that too many sites will use them.
Coming back to share valuations, I can see a few more years of solid growth for Google’s existing core business, followed by a gradual decline. The big question is whether new sources of revenue can be obtained either through acquisitions or through internal developments like Google Earth.
One important question is whether Google can maintain the high levels of goodwill its earned so far (especially by comparison with their obvious competitor, Microsoft). I’ll talk a bit more about this next time.
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nnyhav 08.20.05 at 10:41 pm
Of course, Google can see all of this.
And the data flow. Sorta the way brokerages can see order flow.
Tudor 08.20.05 at 10:56 pm
Needless to say, it’s hard (and somewhat foolish) to predict what will happen in the next 20 years, or which companies will remain relevant.
However, I do disagree with your analysis of google’s wellbeing. For one thing, Google’s profit is not so much related to it’s products (e.g. search, google maps, etc). Indeed, Google’s profit is coming directly from advertisers. And Google Ads are everywhere — especially in blogs. Even if people stop visiting google.com they will still see google text-ads on many of the sites they visit.
RSS feeds won’t make ads irrelevant — even at some remote time in the future people will still have to visit a web page to get the information they want, a web page that will likely have google ads embedded in it.
Thus, I’d say that Google’s core business (of selling ads) is doing incredibly well (they have a huge distribution channel).
But its side business are doing well too. You keep emphasising blogs as the main challenger to Google’s hegemony. But let’s not forget that Google’s Blogger is probably the most popular blogging platform out there. And let’s not forget that many blogger sites carry google ads.
Last, the semantic web will make google thrive — and indeed, they’re one of the main proponents of the semantic web. Their search engine is not just a “dumb” algorithm, but an algorithm that is intelligent enough to rank pages according to what people think about them. In other words, google is all about “making (intelligent) inferences” about data which is what defines the semantic web.
At any rate, it’s much too early to predict Google’s demise. All I see now is a lot of potential.
Dirk 08.20.05 at 10:59 pm
I think Google is overvalued, and I think one factor investors underestimate is that many of Google’s customers aren’t happy with them. By customers, I mean the people who pay for the ads that make up most of their revenue. Yes, Google has goodwill among users of google.com, but less so among the people who advertise.
Advertising on Google and its affiliates in its ad network simply isn’t as good a deal as it once was, as competition from other advertisers have driven prices up. Good for Google, but this means it is unlikely that revenues will grow the way they have the past few years. And there is the huge problem of click fraud, which scares off advertisers and causes lower bids for ads. Google’s recent filing with the SEC even mentioned click fraud as a threat to the business.
Barry 08.20.05 at 11:54 pm
The last few times I’ve tried shopping with Google (main page, or through Froogle) have been a severe disappointment. When I typed in search term ‘X’, there were a number of ads for ‘X’, from places which didn’t carry X; they merely put it in their add. The unsponsored links stank, as well.
ArC 08.21.05 at 12:06 am
Google, so far, may point to Wikipedia for facts, but it’s worth pointing out that Wikipedia’s own search engine falls over so often that half the time it fails over to Google anyways.
As for blogs, I suppose Technorati etc might be handy for what blogs are saying about a very current topic, but I find Google sufficient for getting the blogosphere’s pulse from (say) a month ago, back when topic X was hot the last time.
(BTW, RSS, to me, is not a search tool; I consider it orthogonal.)
I agree with Tudor, BTW: ads are where Google makes money. Google technology tries to back-apply semantics onto unstructured data for the purposes of matching ads to content. They bought Blogger and Picasa to, as far as I can imagine, get people to create more content so they have more places to sell ads. The search result ads are probably a small part of their total revenue, though I admit I haven’t looked at the numbers; it’s just what I get a sense of from the last time I read about Google as a business.
Anders Widebrant 08.21.05 at 3:03 am
“This opens up the possibility of using known structure to get information, rather than seeking random matches for search phrases.”
But Google, importantly, does not return random matches. It returns ranked matches, trying to put the most useful candidates on top, which is a point that seems to be lost on “semantic web” tools. Most people, myself included, do not want to scan fifty RSS feeds to pick out the nuggets, when a single search or news site can do the filtering for us. Tag-based tools seem to suffer from the same reluctance to promote the popular and relevant information at the expense of the mundane or mediocre.
Dirk 08.21.05 at 8:25 am
“get people to create more content so they have more places to sell ads. The search result ads are probably a small part of their total revenue,”
No, as far as the split between search ads and content ads, most of the revenue comes from search ads. Their SEC filing, http://www.sec.gov/Archives/edgar/data/1288776/000119312505170553/ds3.htm , says that 46% of their first-half 2005 revenue came from their affiliates network. This includes both content ads and search engines like AOL and AskJeeves, where the ads show in response to searches. I’d guess about 30% of the revenue is from content ads.
They also state that 11% of their revenue comes from AOL. If Time Warner develops its own ad program or switches to Yahoo’s (both real possibilities), this will seriously affect Google.
Kerim Friedman 08.21.05 at 9:25 am
I have no opinion as to what the actual market value of Google might be, but I find you discussion of the “semantic web” vs. the “conscious design model” interesting. My feeling is that it is unlikely that the vast majority of users will ever fully embrace the semantic web, and so sites like Google will remain an important entry point. The vast majority of web users have never heard of RSS and only a tiny minority actually use RSS feeds. But more to the point, I think you overstate the importance of being a “search portal” to Google’s business model.
The main innovation at Google was not search, but advertising. There are very few services that deliver contextual ads, and people pay a lot of money for Google ads that show up not only in search results, but also in blogs, and other contexts. They have even been successful at getting their ads into RSS feeds. Now they have also opened up their Map API and I’m sure they intend to use Google Maps to deliver localized ads as well. There are even rumors that they are working on entering the Wireless internet access market in order to make use of localized ads.
But, back to the search portal issue. I read something on CT a year or two ago about how poor most internet user’s searching skills are. Most people just use whatever is the default search engine in their browser. That’s why so many people continue to use MSN. If Firefox continues to gain market share, so will Google.
abb1 08.21.05 at 1:11 pm
I think there might be an element of self-fulfilling prophecy at work here. With billions of dollars in the bank Google can buy a helluva lot of related businesses/technologies and build its own empire that’s pretty much shielded from competition and creates the reality and future as it wants, something like Microsoft. If this is what’s hapenning, then Google may not be overvalued at all. But it’s a gamble, of course.
Seth Gordon 08.21.05 at 3:26 pm
Google’s most important asset is that it is sitting on the world’s largest operating system. If placing ads on search engines stops being such a lucrative business, but there’s some other way to make money doing some computer-intensive task for large numbers of people, then Google’s low cost-per-CPU gives it a leg up on just about everyone else.
I have no idea if this technical advantage justifies Google’s $250-a-share price, but it’s an advantage that many analysts seem to overlook.
lth 08.21.05 at 3:42 pm
No-one has mentioned GMail yet. Yes, it’s a free service, but my gosh it’s a good one, and that features more Google ads.
Also – if you have a Gmail account, probably like me you use it to send files and links and so forth to yourself. How long until Gmail becomes the “Google grid” that will store *all* of your important information? They already give away more than 2gb of disk space just for email – imagine if everyone were to keep their documents and mp3s online, especially if Google get to show you text ads every time you load a page. Alternatively, they could even charge for the service – I’d buy it.
Further – GMaps. Again, an absolutely cracking bit of software that links in with advertising. There’s no point using any other mapping software, and it also supercedes things like Yell.com.
It seems to me that Google is very well-placed to become the next Microsoft within 20 years; that is, totally ubiquitous.
smuttynose 08.21.05 at 3:47 pm
“For current information, the main Google search engine is pretty much useless”
You lost me there……….heck, Google has become a verb meaning “to search the inernet”. What am I missing?
Tom Lynch 08.21.05 at 7:21 pm
lth has it right from my point of view. Google’s search technology will come back to the field in the next few years, and MSN/Yahoo will provide results of similar quality (if they don’t already). But Google’s momentum as market leader in search, and their already proven ability to deliver amazingly good browser-based applications should keep them turning the taps of the Internet for a long time into the future.
For as long as they are the main port of call for people searching the net they will have a strong revenue stream from internet advertising.
Great leaps forward like Gmail (which totally redefined the webmail experience) are why Microsoft fear Google – because they might turn around and release a Microsoft Word clone that runs embedded in a web page and stores your key documents online, allowing you to compose, edit and view them from any PC with a standards-compliant web browser at any time. Or store MP3s and listen to music, or …
If this happened, it would in one fell swoop remove one of the few remaining strong reasons for personal users to stick with Windows – that it runs the applications they need and are used to. Google’s brand is strong enough to pull a large chunk of users with it.
Bill Gardner 08.21.05 at 8:05 pm
Let’s assume that John is right and we are beginning to see the ‘semantic web’ come into being. There will still be an important role for search engines, albeit more advanced ones than current engines. Those engines will presumably combine word-indexes, data on links, and meta-information (like tags). I’m guessing that these engines will require substantially more computing power than current models. If so, as Seth Gordon points out, Google’s research on building very, very large computing platforms may provide it with a continuing advantage.
Jeremy Fischer 08.21.05 at 9:07 pm
May I point out that the number of shares reported has nothing to do with the transcendental constant Pi, but rather with the irrational value for the square root of two. That is to say, the number which–multiplied by itself–equals two. It begins 1.414592…etc.
Tom Lynch 08.21.05 at 9:44 pm
Actually, it is pi – or the fractional part of pi at least. The value of the square root of 2 is approximately 1.41421356…
The value of the fractional part of pi is .14159265… the same digits as appear in the Google share offering.
joe o 08.22.05 at 4:05 pm
I think Google is overvalued. I think they know that and they want to capture some of that money now to give them the ability to do things even if the stock flatlines or goes down.
uptown 08.22.05 at 7:52 pm
Google link ads are a pain, and Barry’s comment “number of ads for ‘X’, from places which didn’t carry X; they merely put it in their add.” should tell you why.
Gmaps — has got me using yahoo! maps again.
Gmail — My ISP does a better job.
As for stock price – I think ‘joe o’ nails it.
liberal 08.23.05 at 6:12 pm
I like the idea of the semantic web, but I think building such a thing is very very difficult from the point of view of information science (i.e., library science).
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