1. Valuing Google © James Dow, 2009 Do not distribute without permission

2. 1996: Stanford Sergey Brin and Larry Page are PhD students in computer science at Stanford University. They are working on a project to develop a better search engine.

3. Initial Funding In 1998, Andy Bechtolsheim, co-founder of Sun, gives them a check for $100,000. They incorporate in September 1998. 1999: $25 million from Sequoia Capital and Kleiner, Perkins, Caufield and Byers.

4. 2004: An IPO is Announced Set for August 2004 Dutch Auction: Investors submit bids Bids are ordered, price sets supply = demand All investors get the same price

5. April 2004: S1 filing with SEC 199920002001200220032004Q1 Revenue22019,10886,426347,848961,874389,638 Income(6,076)(14,690)6,98599,656105,64863,973 Per share(0.14)(0.22)0.070.860.770.42 Diluted(0.14)(0.22)0.040.450.410.24

6. How to forecast the rest of 2004? 20032003Q12004Q1 Revenues961,874178,894389,638 Income105,64825,80063,973 Per Share0.770.200.42 Diluted0.410.100.24 (2004Q1) x (4) 2004 1,558,552 255,892 1.68 0.96 (2004Q1) x (2003) (2003Q1) 2004 2,094,998 261,962 1.62 0.98 Actual 2004 3,189,223 839,553 2.07 1.46

7. Google vs. Yahoo Google20002001200220032004 (actual) Revenue19,10886,426439,5081,465,9343,189,223 Net Income(14,690)6,98599,656105,648399,119 Per Share(d)(0.22)0.040.450.411.46 Yahoo20002001200220032004 (actual) Revenue1,110,178717,422953,0671,625.0973,574,517 Net Income70,776(92,788)42,815237,879839,553 Per Share(d)0.06(0.08)0.040.180.58 How do they compare in terms of revenue? How do they compare in terms of profitability?

8. Pricing Google with P/E Ratios Assume Google is just like Yahoo in 2004 Yahoo shares sold for around $30 Yahoo earned $0.58 per share This gives a P/E ratio of 52 $30/$0.58 = 52 Apply this to Google’s earnings of $1.46 per share. Google should trade for $76 $1.46 x 52 = $76

9. What if we knew 2005? Google earnings = $5.02 per share Yahoo P/E (2004 price to 2005 earnings) = 24 At 24, Google price = $120 $5.02 x 24 = $120 At 52, Google price = $261 $5.02 x 52 = $261

10. What should you bid? $76 based on 2004 information? $120-$261 based on 2005 information? Google’s “guidance” of $108-$135?

11. August 2004: The Actual IPO Our estimates range from $76 to $261. And the auction price is: $85 The next day the price jumps to $104. It reaches $198 by the end of the year.

12. What happened after 2004? GoogleYahoo 2004256%222% 2005243%121% 200698%-22% 200734%-10% 200821% (est) 45% (est)

13. In 2008, Yahoo turned down an offer to be bought out by Microsoft and its continued existence as an independent firm is questionable. Google is now the 15 th largest company in the US by market capitalization.

14. Discounted Cash Flow

15. Why discounted cash flow? Earnings do not grow at a constant rate. Google earnings grew 256% in 2004 34% in 2007 Using multiples assumes that other stocks are priced correctly. The price of Yahoo fell in 2005 despite earnings more than doubling.

16. How to do it Step 1: Estimate the cash flow for each year. At some point, assume constant growth. Step 2: Determine the appropriate discount rate. Step 3: Discount the cash flows and add them up.

17. Step 1: Estimate the cash flows YearFCF Growth 2005100%+ 2006100%+ 2007100%+ 2008~90% 2009~70% 2010~55% 2011~44% 2012-2018Down to Below 10% 2019 on3% YearEPS(d) Growth 2005243 200698 200734 200821 (est) Business Week, 2004Actual

18. Slight of Hand Earnings > FCF > Dividends In long run they should grow together Not so much at the start FCF hard for us to calculate

19. Handling the terminal value Pick a growth rate (5%, 3%) Value as a perpetuity Discount to the present

20. Step 2: The Discount Rate Base rate + risk premium CAPM and Beta BW: Beta of 2 and discount rate of 17.4% Later, others use discount rates as low as 10%

21. Step 3. Present Value

22. Sensitivity Analysis Base price = $110 g = 0.03: price = $103 R = 0.15: price = $140 R = 0.10: price = $298

23. How do the values compare? Actual price: $85 - $198 P/E estimates: $76-$261 DCF estimates: $103-$298

24. Warning These are ballpark estimates. If doing this for real you should be much more careful with the data.