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August 29, 2005

How Many Pieces In A Google Pi?

Pi is a small number with a lot of decimal points after it: 3.14159265 etc., which apparently goes on forever. Google’s new issuance of shares, 14,159,265, is a large number with no decimal points after it, which apparently goes on to be worth about $4 billion in cash. (See how the number of shares they are selling is the same as the first eight decimal points of Pi? Get my clever/stupid blog title now?)

When I think Google, I think “search.” I don’t think community applications, social networking, VoIP, software, email or digital music. “Googling” is “searching.” For this reason, I think there is one piece in a Google Pi and it is Search. But what does search look like in the future?

Let’s assume that the reason for Google’s new issuance isn’t that they consider their stock overvalued and therefore just took some money off the table. Let’s further assume they raised the cash to make some acquisitions. What would they buy?

Google sure is a great company. With sales of $4.5 billion and trading at more than a 17x multiple, they have an impressive market cap of roughly $80 billion and with a ~32% operating margin they are generating well in excess of a billion and a half EBITDA annually. So figure they’ve got around $3 billion in the bank. Add another $4 billion to get $7 billion and you start wondering why that is the right amount to execute on their apparent plan to grow through acquisition. You can buy a lot of small companies with $7 billion, but the integration cost is too high if you buy too many, so you do it sparingly. A company like Google buys a small company when they are building a new value chain and have some links missing and their build/buy analysis points to buy. You cannot buy a big company because they are simply unaffordable. MSFT: $291B. EBAY: $52B. YHOO: $47B. (BTW, I personally think YHOO compared to GOOG is undervalued, and if you look at the fundamentals of each, you will likely agree. Same revenue, better profit margin, lower multiple. Is a search company really valued on “search” or is it valued on how many ads it can sell against its inventory? I just convinced myself to buy more Yahoo.)

So that means Google is most likely going to buy some medium-sized companies in areas that move the revenue needle measurably and some small companies where there is a strategic fit to build new value.

This post is divided into the three major strategies I see that Google could execute to fuel growth through acquisition:
1) Buy more inventory
2) Focus on International
3) Focus on Local Search
…plus a fourth area that I think ties them all together that I just know a major player is going to figure out sooner or later and it might as well be them. That is:
4) Be the largest LMNO.

1) Buy inventory in different forms
Medium-sized acquisition top pick: Skype. (Yes, me and everyone else, but this only really makes sense to me if Google also buys my small company acquisition top pick, TellMe.)
There is some speculation about Google buying Skype.

What would it give them? Skype kicks much ass, and is a truly disruptive technology. Owning Skype is like owning all phone calls in the future. Many more people make a call every day than search for something on the web. Think about the Skype interface. Could you monetize that? I could. And so could Google. Plus it is sticky in a way that Google isn’t if you believe it is possible for a better search engine to challenge them.

What would it cost? Several billion. Math: Let’s say MySpace has around 15 million active users. At $580 million, News Corp. is paying around $38 per user. Skype’s website boasts in excess of 51 million users. If the going rate for user acquisition is $38, then around $2 billion should be about right. But Skype is rumored to have turned down multi-billion dollar offers. So then they are simply not for sale or they believe there is sufficiently massive upside to their business in the future combined with a low enough threat of competition that they can realize larger gains going it alone. In any case, on its own this doesn’t make sense to me unless there is an interface to tie the Google ad-based world to the Skype transaction-based world. For this, I like TellMe.

Small company acquisition top pick: TellMe. I absolutely love this company. It’s the kind of company entrepreneurs wish they had started. Call ANY big company and the annoying but cost-effective “natural language” voice-recognition menu system is probably powered by TellMe. (“Hi, this is Julie. I thought I heard you say, ‘I want to talk to a real %$#@! person.' Did I get that right?”) TellMe is internet-powered telecommunications, and it is the link that is missing between Google and Skype (or Google Talk.)

What would it give them? A telephony-based front end for search. This acquisition makes so much sense to me that I can hardly believe it hasn’t happened yet. If you believe that phones will replace computers and Google with voice recognition would be the ultimate killer app for the phone, then combine this acquisition with Skype and Google can close the loop, essentially owning the whole telephony search value chain in two simple acquisitions. They would have the user relationship, the interface, the network and the inventory.

What would it cost? With revenue around $100 million for the year, a 10x multiple, while generous, would not be out of line, and it might be more than the public markets would represent when the company finally executes on its long-anticipated IPO plans.

2) International expansion = good
Medium-sized acquisition top pick: Baidu. (Yes, more bandwagoning here, but look at the major emerging international markets and you'll see India is unattractive and that leaves China.) Google makes money by selling ads. The more inventory you have, the more ads you can sell. All the hype around Baidu lately whipped up speculation that Google may have to buy them or else miss the gigantic opportunity that is China.
Impossible? A similar thing happened to Ebay, which got its ass handed to them by Yahoo Japan.

The price is looking more attractive now that they have lost 35% of their value since their meteoric IPO.

What would it give them? In the case of international expansion, I would rather see Google spend the money internally on a massive organic growth strategy. Put (a lot of) people on the ground in international markets that matter and grow battle ground by battle ground the way Ebay did. Sometimes you lose, but if you stick to what you do best, most of the time you win. That said, this post is about acquisitions, so I’ll jump on the bandwagon and say Baidu looks pretty good, particularly because as far as international markets go, China looks very promising, despite its highly censored version of the internet.

What would it cost? Google already has a stake in Baidu, so this acquisition makes sense if you think at ~$3 billion, it is worth it to get in on the ground floor (current total online revenue in China: $1.1 billion) of a market that is going to dwarf the U.S. at some point in the future.

3) Focus on local search
Nobody does local search very well, least of all the biggest internet search engines. Because the internet is placeless, relevance ranking is based on how many people link to a site or the traffic it gets or the keywords they buy. Stand on a street corner in New York City and search for “Steakhouse” in "new york" and observe the results. Use Google web and you get Outback Steakhouse, which ignores your location. Use Google local and you get Smith and Wollensky, which ignores your proximity. Try to drill down on Google Local to “Manhattan” and it doesn’t know where that is. I am serious. Google Local doesn’t know where Manhattan is. Try it yourself.

Yes, I am sure there is a Manhattan in the UK, but now we’re back to the need for a relevance ranking engine that is entirely different if Google is going to do local search.

In fairness, it knows Manhattan zip codes, but people don’t know zip codes other than where they live and work. I don't have to search for a steakhouse around where I live because I have tribal knowledge of where I live. This is a major UI problem, and a nontrivial issue that means they are going to build some cool new stuff or they are going to buy someone who puts them seriously into local search.

Medium-sized acquisition top pick: InfoSpace. Recently, investors have proven they apparently don’t see the upside of this great company, but maybe they are simply the piece of a larger company that has been missing. FYI, I objectively believe in this company. I have no financial interest in INSP and sold all of my stock long ago. (At 55 :-P)

What would it get them? A mobile, local bolt-on strategy. InfoSpace has smart people, great assets and a search engine optimized to make their local data relevant. Plug it in to Google Local and slap on a mobile phone-based interface and they instantly become the most relevant search conglomerate in the free world. If you believe local search is the holy grail because owning that “last mile” to enable people to find everything around them gives you the power to become a sort of personal portal to all services that anyone could ever want, then you will see the logic of this acquisition.

What would it cost? With a nice premium, INSP could be had for a little less than $1 billion, which is way less than this company is worth, in my opinion. Plus, with $400 million in the bank, you get a nice rebate on your purchase.

4) Connect the dots to be a huge LMNO
Google could spend the money to be the largest LMNO. They have the technical skill to build a Skype competitor, and the reach to distribute it. Google Talk could beat Skype eventually, if they come at it from a different angle, like voice communication is about Phone Call 2.0, not Skype's Phone Call 1.0.

Here is the GOOGLMNO value chain:
Google Search +
Blogger (distributed network of people plugged into Search) +
Google Talk, Gmail, and [missing: IM and social networking, but they just bought Meetroduction] (most familiar communication protocols to connect people) +
Google Local [missing: Better local POI like InfoSpace] +
Dodgeball (Proximity-based local overlay for aforementioned media networking construct) +
[missing: Mobile thick-client footprint] (distributable addictive mobile communication client that rolls up blogging, social networking, IM, messaging and possibly a Skype-like client all as a front end for their core product, Search.)

Simply put, GOOGLMNO would be the interface that enables users to find anything from any source through a network of other users via every communication protocol available. Interestingly, it isn’t that hard to put together and doesn’t require a paradigm shift in user behavior. More interestingly, Yahoo and MSN may actually be better positioned for this. Most interestingly, IAC, AOL/Time Warner or News Corp. may be best positioned because their media assets add particular value to the future of communication which is really personal networking through media creation, attachment and redistribution.

Posted by Shawn Conahan at August 29, 2005 07:09 PM

Comments

Posted by: Juan at September 6, 2005 11:06 AM

Posted by: Shawn Conahan at September 6, 2005 10:03 PM

Posted by: Juan at September 7, 2005 11:07 AM