How Google's new business model hurts GOOG

How Google’s new business model hurts GOOG.
Written by Donna Bogatin, Contributor on
Before the new year, Fast Company magazine asked for my take on Google’s prospective financial performance in 2007. 

In “Google due for a fall?” I present my analysis of GOOG 2007:

In 2007, GOOG will be negatively impacted by a continued decline in the growth rate of Google's earnings per share. Analysts forecast a 36% growth in EPS for Google in 2007 ($12.63), versus its 78% rate in 2006 and a 172% rate in 2005. As Google's earnings growth slows, its share price to earnings ratio will also fall; GOOG's 2006 PE of 50 is likely to dip to 36 in 2007. A GOOG 2007 fair value of $454 (36 PE X $12.63 EPS) is below its 2006 closing price.

I concluded “Search for a better investment opportunity in 2007.”

The financial ramifications of Google’s move into paid SaaS today (see “Google undercuts Microsoft Office”) support my contention that Google continues to become less attractive to Wall Street in 2007.

Why does the Google Apps Premier launch portend a downward trend for GOOG?

The Google version of Microsoft Office may be housed in the Google cloud, but it nevertheless must support service delivery on the costly real-world ground for telephone support, service guarantees…

As Google acquires customers, Google’s incremental costs increase, and the more Google Apps users use the service, the more Google’s cost of delivery increase.

George Reyes, CFO, Google, Q4 2006 earnings call:

Turning to a favorite topic of ours, capital expenditures for the quarter totaled $367 million, bringing total capital expenditures for 2006 to $1.9 billion. The majority of our CapEx is related to IT infrastructure investments, including data centers, servers and networking equipment. Our leadership in search and ads is a direct result of our relentless focus on building the most robust platforms for our users. As we scale, our business increasingly requires substantial computational power.

In 2007, we expect to make significant capital expenditure investments. It is important to point out that the strategy of aggressively investing in our infrastructure has paid off handsomely and remains critical to our success, and we intend to follow this strategy for the foreseeable future.

Google scaling in Apps premier will require an even greater Google investment in “building the most robust platforms for our users,” given Apps Premier is a for-fee enterprise service with SLAs (see “Google Gmail SLA guarantee?”), not a no-fee consumer Internet search experience.

While Google will face rising costs from its Google Apps Premier commitment, it will be constrained on the revenue front. From the get-go, Google is losing money on Google Apps premier, as it is providing it for free through April 30, 2007.

Google set a $50 per user, per year price point to position itself as the lowest cost provider.

Dave Girouard, vice president and general manager, Google Enterprise:

With Google Apps, our customers can tap into an unprecedented stream of technology and innovation at a fraction of the cost of traditional installed solutions.

With scant pricing power and an open ended cost structure, Google Apps Premier risks the fate of Google Checkout: Google Checkout is a loser, really.”



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