We bring to your attention an adaptation of the article by Rick Webb (Rick Webb) Google's $350 Billion Haircut translated into Russian.
What is the price of Google? Today, the market capitalization - the total value of the company - is just over $690 billion. It is the largest media corporation in the world. Out of a total of $90 billion in revenue, $79 billion comes from media. 87% of Google's revenue comes from advertising. All these cool things that are being buzzed around like drones, Google Fiber, Nest, Verily, Calico Labs, Google Ventures, Google X are less than $809 million, which is far less than 1% of total revenue. What about Facebook? The value of this company is just over $500 billion. In 2015, she earned about $17 billion through advertising. In the same year, total revenue was $18 billion, representing a 95% percentage of advertising revenue.
What is the picture with traditional media companies? Take Disney, the largest traditional media company in the world, for example. Disney made $55 billion last year. Of that amount, only 15%, or $8.5 billion, came from total advertising revenue. This includes all earnings from ABC, various Disney channels, ESPN and A&E. To be frank, Disney owns large minority stakes in Hulu and Vice, and it looks like these financial gains are not included in the annual advertising earnings report. Let's miss this point, it's just another argument in favor of what I'm talking about here. The market capitalization of Disney is about $150 billion.
Disney, with its super amusement parks and massive retail business, is something special. However, its history is typical of other major media companies as well. As a rule, they all own movie studios, cable companies and magazines, which are a source of advertising revenue. 17% of Time Warner's revenue comes exclusively from HBO. According to general estimates, Time Warner receives only 43% of its total revenue from advertising. For Viacom, this is 37%.
Indicators
Looking at these numbers, one thing is clear: the total value of each company is greater than its annual revenue. In high-risk investing—venture investing—this is called multiple on revenues. In the stock market, the idea boils down to the P/E ratio (the ratio of Price to Earnings).
The bottom line is that someone who acquires a company is more likely to want to pay more for it than its annual income, because it is likely that next year will be able to earn even more than this.
What does this mean? For example, a certain company is put up for sale, its annual income amounted to 120 million. So, given the prospects and favorable development forecasts, a potential buyer will be ready to purchase it for an amount exceeding 120 million. After all, next year they can earn 150 million, then There is an investment that will quickly pay for itself. As a rule, these indicators (coefficients) are applied to the assessment of all companies in the industry. They vary, may be higher or lower. Following the basic economic theory that you are taught at the university, this is a confrontation between capital-intensive and labor-intensive business. The idea is this: for example, you bought a factory, but all the people quit and left it, then you still have the factory itself with equipment and machines. But if you bought a law firm, and all the employees left, everything,
Previously, manufacturing companies had higher rates than service companies. If you are considering acquiring a widget company with $100M in annual revenue and compare that to buying a law firm with the same $100M in annual revenue, you would be shelling out $500M (5x) for production, while the legal the company may be worth 200 million (2x). Here are the corresponding multipliers of 2x and 5x. I choose these numbers for a reason. Among investors, multiplying a service company's income by 2 is the default starting point. Multipliers (coefficients) are extremely important for the company. The higher the P/E ratio, the higher the value of the company's shares. Shares are money that can be used to buy other companies. A high P/E ratio makes a company more valuable financially successful, which helps to outline the circle of its potential buyers. There are only a handful of companies on the market right now that can even entertain the idea of buying Google or Facebook. In fact, the only such company is Apple, and that's about it.
So, looking at the P/E ratios for these companies, the picture today is as follows:
Google 36.49;
Facebook 37.74;
Disney 17.24;
Viacom 7.18;
Time Warner 18.65.
Viacom is a little off the list: it's a much smaller company than the others on the list and, to put it mildly, has some issues with succession issues.
Metrics for technology companies
To give an example, tech companies have a much higher ratio than traditional ones. And Google and Facebook are especially high. Apple has 17.86, Microsoft 28.61. some are higher, much higher. Amazon has a staggering 253.06. it seems that technology companies do not have very high P/E ratios if production is done the old fashioned way, for example, in a factory way. It is worth recalling that in the old days, production indicators were higher than in intellectual companies, which are based on human resources. In fact, with the growth of just-in-time logistics, this is no longer so relevant. But what's really strange is that companies with excellent growth prospects that have real income without advertising are valued less than those that rely solely on it. Certainly, someone may quite rightly remark that if all IT developers leave the company overnight, then this is much more difficult than if all lawyers leave it. But despite this, Google and Facebook, and indeed the entire technology industry, has huge numbers. The high performance of technology companies has historically been justified by two reasons:
Firstly, they are promising, and, in general, this makes sense: you would rather buy a company that is growing rapidly and successfully than one that is completely stagnant.
And secondly, technology companies have earned higher numbers by being able to organize their business at a lower cost and/or more efficiently than their "traditional" competitors.
These theories about metrics have been confirmed in the early history of Google. They received their first income, having a small number of employees. Google grew and did it very effectively. And the market seemed bottomless. But since then they have changed. Perspective is what we talk about all the time in this part. Facebook and Google are winning the battle for commercial advertising, but losing the war in the larger and more lucrative area of TV branding. Their potential is severely limited. Despite the fact that Mary Meeker and other analysts have been touting the inexorable migration from TV to the Internet for more than a decade(and then to the mobile realm), this migration did not happen, and there is no reasonable economic case to think that it will ever happen. Google and Facebook annually receive about $600 billion from advertising. This number grows only with GDP growth, and we probably will not see GDP growth. Of course, Google's core business is the search engine. But there are also some concerns. It is constrained by the pace of globalization and incumbent competitors, of which there are a lot (especially in China). Advertising figures are extremely stable relative to the level of GDP, and its significant growth is not expected in the near future.
Capital assets VS human resources
Technology companies have always achieved better results by being able to organize their workflow more efficiently and by not failing to select valuable and irreplaceable talent. But I will tell you one thing. If I were a billionaire private investor named Schmidt Bomney and I wanted to buy a company I don't know anything about, I'd rather buy manufacturing and replace all the employees who left than Google would, and I'd be dumped by all these computer geniuses.
Economic benefits
Previously, Google had far fewer employees and provided subdivided advertising at a much lower cost. Not only did they not need a massive set of people, but they did not have to own all these expensive printing presses. As we said earlier, all this is no longer relevant in the struggle for the remaining untapped advertising financial resources. Everyone, in fact, ALL, wants to fight for those remaining advertising dollars (referred to as TV).
And it really comes at a cost. Apple is spending a billion dollars to play its game with Spielberg. They are bringing back Amazing Stories and I have to admit, I'm excited about it. And this is only a small part of the 7 billion they plan to spend. Facebook spends money on Buzzfeed, Vox and other content. They plan to spend about a billion dollars. Netflix - $6 billion. Amazon - 4.5 billion. Hulu - 2.5 billion. Google - 4.5 billion. Oh yeah, and everyone was spending money with Weinstein (thus). It all sounds like fantastically huge sums. And so it is! Absolutely everyone spends a lot of money on great content. There is no reason to believe that a tech company can create content better than the rest. She has zero advantage over Disney. Disney already has substantial TV advertising revenue and a wide track record of creating content that everyone loves. Tech companies have no advantage in this, there are many innovative advertising companies, who will be no less happy that they will be acquired by Disney, not Google. Google and Facebook have no price advantage when it comes to fighting for those last few ad dollars. And they don't even have the money to wage this war of attrition. Google has $92 billion, Facebook has plus/minus 30. Newly minted content producer Apple, by comparison, has $256 billion in the bank. Disney has about $12 billion, but comparing that figure to other companies is unreasonable because when it comes down to it, the amounts tech companies are willing to spend on content are minuscule compared to Disney. Disney's cash flow is a different story, because they're already spending astronomically more on content than any of these tech companies can imagine. The total budget for 10 Disney films released this year is $1.5 billion. ESPN spends another 2 billion a year on the NBA alone and 1.9 billion a year on the NFL. And $700 million in MLB. And about a billion more in College Basketball. Half a billion on CFP. Another half a billion for Big Ten Rights. It's a bit tricky to calculate the total because Disney amortizes its content over different years in its annual report, but the estimated $10 billion figure seems reasonable. And that's not counting amusement parks and significant cost savings, which Disney pays for by creating something like " And about a billion more in College Basketball. Half a billion on CFP. Another half a billion for Big Ten Rights. It's a bit tricky to calculate the total because Disney amortizes its content over different years in its annual report, but the estimated $10 billion figure seems reasonable. And that's not counting amusement parks and significant cost savings, which Disney pays for by creating something like " And about a billion more in College Basketball. Half a billion on CFP. Another half a billion for Big Ten Rights. It's a bit tricky to calculate the total because Disney amortizes its content over different years in its annual report, but the estimated $10 billion figure seems reasonable. And that's not counting amusement parks and significant cost savings, which Disney pays for by creating something like "Star Wars Rebels , for example. It's a very low cost show for the company in terms of production because Disney already owns Star Wars, the mythology, the production capabilities, and the writers. It also doesn't include billions in physical production assets such as film sets and Disney studios. They already have all this.
This state of affairs plays an important role in explaining what else Google is betting on. For example, the Berkshire reorganization of the Alphabet holding company . Facebook, in turn, advertises drones and VR as potentially promising opportunities ( not always successfully, true), and, despite everything, loudly declares that it is not a media company. Seems to me they protest too much. Strategically, it's a smart move for Google and Facebook to get massive ad dollars now and, while their shares are so expensive, invest in other industries. However, they are far from achieving these goals. This also explains the Google Alphabet reorganization. Alphabet allows them, as well as other investors, to evaluate all these attempts separately (investors hate all sorts of conglomerates). EMC had the same problem with the Pivotal split. Time Warner went through this with HBO. This is nothing new, and Google doesn't have any tricks up its sleeve when it comes to that age-old corporate problem - "share unlocking."
Summarize
Frankly, I don't think Google really deserves its P/E of 36.5. We have already found out that Google has no special advantages in the field of TV advertising. Moreover, the market is changing, which means that along with huge competition, advertising prices can also decrease significantly. Disney would have a much more reasonable P/E ratio - that would be quite appropriate. Disney has an impressive and growing digital business and, unlike Google, they don't have major and ever-emerging antitrust restrictions. Disney's real earnings and assets - amusement parks, IP goldmine, studios, TV channels such as ESPN, ABC, DisneyXD and 33% of Hulu - all clearly contribute to winning this big advertising war. From what Google has today, there is not much to oppose them.
But let's play nobility and give Google the same P/E of 17.24 instead of the current 36.49. This means a 53% reduction in the ratio, bringing Google's new market value to $325 billion and the company's share price to $433.38. This seems much more reasonable. Likewise with Facebook, the P/E ratio should be around $217 billion and trade at $74.70. The only argument in favor of Google and other companies in the battle for the advertising business is their large P/E, value and share prices, which makes it much easier for them to acquire young and successful content developers. But these reserves are based on a changing reality that ceases to exist. So it turns out that not everything is so simple!
GO TO FULL VERSION