Interesting research note in my mail today from Christa Quarles of Weisel. Highlights:
Headline risk, Checkout and other issues have weighed on Google’s stock year-to-date: Google’s stock is up just 2% year-to-date, compared to a 2% increase in the S&P 500, but nearly a 25% increase in Yahoo!’s stock over the same period. We believe the following issues have weighed on the stock: litigation with Viacom over YouTube; partnerships (such as with Fox) not being quite as robust as expected; expense creep related to Checkout; and a perceived lack of focus in trying to service traditional media.We believe Google’s core search business remains strong, however, as query share continues to improve (Google gained over five points of global query market share over the past year and over 16 points over the last two years) and incremental dollars into search tend to follow the users (who then convert). We expect Google to garner nearly all of the incremental dollars into search in 1Q07, suggesting its core business remains strong. As such, we remain comfortable with our 1Q07 estimates that call for $2.5bn in net revenue (up 13% q/q; 64% y/y) and pro forma EPS of $3.35. Search growth is decelerating, however, and begs the question: what will the next big ad category be for Google? We believe the definitive answer is mobile….
…Valuation:In 4Q06, Google’s organic net revenue increased 73%, compared to 21% for eBay and 14% for Yahoo!. Currently, Google trades at 18x FY07E EV/EBITDA, compared to 16x for eBay and 16x for Yahoo!. Given the high capital expenditure spending compared with eBay and Yahoo!, however, we believe EV/EBITDA less capital spending is a better metric for comparison. On this basis, Google trades at 27x, compared with 23x for Yahoo! and 20x for eBay. Our discounted cash flow (DCF) analysis, which assumes 25% annual 2007E-2012E gross revenue growth, a 12% weighted average cost of capital (WACC) and a 15x 2012E EBITDA exit multiple, suggests a current fair value of $570 on the shares. We rate the stock Overweight.