CaseGoogle Valuation.docx
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CaseGoogle Valuation.docx
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CaseGoogleValuation
Google:
Valuation
TheGoogleIPO
Google’sIPOon19thAugust2004wasmuchpublicizedasthefirstmajorInitialPublicOfferingontheNASDAQsincethedotcombust.TheSECfilingstated“Googleisnotaconventionalcompany.Wedonotintendtobecomeone”.1Google’sIPOtooktheboldexperimentalapproachofsellingsharesbyDutchauction.Dutchauctionsstartwithhighbidsanddecreaseinpriceuntilallavailablesharesaresold;thenallbidderspaythelowestsuccessfulbidpriceinasimilarmannertotheWhartoncourseauctionsystem.Asisthecasewithallauctionsthereisariskofthe“winnerscurse”i.e.investorsoverpayingforthesharesinordertowinthebid.NormallyIPOpricingisundertakenbyinvestmentbanksperformingvaluationsandthenpricingtheInitialPublicOfferingtoappealtolargeinvestorswithaguaranteedofferprice.ThebanksundertakeaRoadShowinordertogaugeaswellasincreaseinterestintheIPOsharesatthesetprice.Toensurethattheshareofferingisasuccess,inthatallsharesaresold,thepricingisusuallyslightlylowtoensurethatthereisa“pop”(priceincrease)onthefirstdayoftrading.Thereby,institutionalinvestorsareabletoreapaprofitfromthepurchaseofsharesbeforetheyareofferedonthestockmarket.Alsothecompanyitselfreceivesfewerfundsduetothelowpricingandindividualinvestorsarenotabletoaccessthesesamesharesuntiltheyarepubliclytradedonthemarket.Thiscanmakeanequityofferinganexpensivewayforcompaniestoraisemoney.TheaimofGoogle’sDutchAuctionwastoallowindividualinvestorsthechancetoparticipateinthepurchaseofIPOsharesnormallyreservedforlargeinvestorsaswellasmoreproperlypriceaccordingtodemandi.e.avoidthefirstday“pop”.2Inadditionitwouldreducetheexpensivebankerfees,typically4-7%ofthemoneyraised,bynotrelyingentirelyonbankerstosettheinitialofferprice.3TheunusualmethodoftheofferingandGoogle’scommitmentintheprospectus“nottobeevil”,togetherwithrowsoveraninterviewwhichGooglegavetoPlayboyandtheprematureissuingofshareskepttheIPOintheheadlines.TheunansweredquestioniswhetherGooglewillbecomeanestablishedfirmorbereminiscentofthedemiseofotherdotcomssuchasNetscape.
GoogleenginebeganasaresearchprojectbyStanfordUniversitygraduatestudentsSergeyBrinandLawrencePagein1988.Existingtechnologyatthetimewasonlyabletoscanthewebandfindpagesthatmatchedparticularwords.SergeyandLawrencecreatedamathematicalalgorithmcalled“PageRank”whichwasabletopresentwebpagessortedinorderofexpectedrelevance.Inordertoachievethiswebsitesarerankedaccordingtothenumberoflinksfromotherwebpagesi.e.whenitispossibletonavigatefromanotherwebsitebyclickingonthetraditionallyblueunderlinedphrase.Theideaisthatthemoreawebpageisreferencedinotherplacesthemorelikelyitistobeimportant,andifitislinkedtoother“important”i.e.welllinkedwebpages,itisevenmorelikelytoberelevant.Eachlinktoapageisviewedasa“vote”forthatpagewhichincreasesits“score”andthePageRankscoreofapageisthesumofthePageRankscoresforwebpagesthatlinktoit.4Therefore,themorelinksthatapagehasthemorelikelyitistobeimportantanditisgivenahigherranking.Whenlinksexisttootherwelllinkedor“important”webpagesthisincreasestherankofthewebsiteevenfurther.Toavoidhavingtocalculaterankusingiterativeprocess,whichwouldslowdownthesearch,PageRankuseslinearalgebrasothattherankingcanbeachievedinasinglestep.TheoriginalPageRankformulaisstillavailableonaStanfordwebpage(http:
//www-diglib.stanford.edu/diglib/pub/slides/berkeleydlijan98/berkeleygoogle2/).Theformulahassincebeenmodifiedtoimproveitsspeedandtopreventpeoplefrommanipulatingtheirsearchrankings.5Infactmanipulationofsearchratingsisarapidlyincreasingserviceofferedontheweb,whichmeansthatGooglehastoconstantlyupdateitssearchprocessandblacklistsiteswhichattempttomanipulatetheirrankings.IncombinationwithPageRankGoogleperforms“text-matching”techniqueswhichcomparesearchquerieswiththecontentofwebpages.Thistechnologylooksatthenumberoftimesasearchitemappearsonawebpageaswellastheproximitytoeachotherofindividualwordsinthesearchqueryonthewebpage.Resultsareprioritizedaccordingtothesefactorsbothwithintherankedpageandthroughtext-matchingonwebpageswhichlinktotherankedpage.PageRanksitsontopofacompleteindexedcopyoftheWorldWideWebwhichisheldinGoogle’sserversinCaliforniaandVirginia.Thewebiscontinuouslyscannedandpagesthatmatchparticularwordsareindexed.Thescanningisundertakenbyhundredsof“spiders”(software)inparallelcrawlingovertheinternetandindexinglinksfromwebpages;onceallthelinkshavebeenextractedfromawebpagethelistoflinksisprioritizedandthenextwebpageisscanned.Indexingworksinasimilarmannertolibraryindexingenablingfilestobelocatedmorequickly.SowhenGooglesearchesthewebitinfactsearchesanindexofacopyoftheWorldWideWebtherebyincreasingthespeedatwhichresultsarereturned.TensofthousandsofcomputerssearchthroughtheindexsimultaneouslyandtheresultsarereturnedinanorderofrelevancebyPageRanktogetherwithadvertisements.
ManagementTeamandCompanyCulture
LikemanycompaniesfoundedinthedotcomeraGooglehasayoung,hardworking,individualistic4,entrepreneurialandcollaborativeculture.ThetopmanagementisorganizedinanunusualtripartitestructurewiththetwofoundersandtheCEO.TheChiefexecutiveEricSchmidtwaspreviouslytheCEOofNovellandjoinedin2001attheageof46.EricwasrecruitedasanexperiencedCEOtobringalevelofseriousnesstothecompany.EricandthefoundersSergeyandLarryoperatecollectivelybyconsultingextensivelywitheachotherbeforemakinganymajordecisions,seeexhibit5.4Google’sboardalsoincludestwoVentureCapitalistsJohnDoerrandMichaelMoritzwhobetweenthembroughtYahoo!
andNetscapetomarket.9ItisrumoredthattheywerethedrivingforcebehindtheIPOandthatthefounderswereinitiallyreluctant.Googlewasnotinneedofadditionalcapitalandgoingpublicbringsamyriadofadditionalreportingcosts.6"Amanagementteamdistractedbyaseriesofshort-termtargetsisaspointlessasadietersteppingonascaleeveryhalf-hour,"theywroteinan"Owner'sManual"attachedtotheSECfiling.7Statinganaimtokeepalongtermfocusandmanagementcontrol,twotypesofcommonshareswithdifferentvotingrightswerecreated:
AwithonevotepershareandBwith10votespershare.TheS-1document4statedthat“Aftertheoffering,64.0%ofourClassBcommonstockwillbecontrolledbyourfounders,executiveofficersandemployees,representing63.0%ofthevotingpowerofouroutstandingcapitalstock.”AnS-1isrequiredbytheSecuritiesandExchangeCommissionasaRegistrationStatementdetailingtheIPOplansundertheSecuritiesActof1933.AftertheIPO,Googleintendstocontinueitsclose-knit,collaborativemanagementstyleandsecretiveoffbeatculture.8Asarelativelysmallcompanywithlimitedhierarchyand2,292employees,atthetimeoftheS-1filing,itisrelativelyeasytokeepthecultureintact.Engineersareencouragedtospend20%oftheirtimepursuingindividualprojectsandsomeinnovationssuchasGooglenewshavestemmedfromtheseprojects.4
SourcesofRevenue
InitialsourcesofrevenuewerebanneradvertisementsandlicensingsearchtechnologytoothersitesincludingYahoo!
andAOL,althoughrecentlyGooglehasbeenmovingawayfrombothoftheserevenuestreams.5In2000GooglelaunchedarevolutionarywayofgeneratingrevenuecalledAdWordsanditsrevenuesincreasedrapidly.AdWordsenablesGoogletogeneraterevenuewheneversomeoneclicksonanunobtrusiveadvertisementwhichisautomaticallydisplayednexttoarelevantsearchresultwithalladvertisersbeingchargedthesamerateperclick.Ontopofthisadvertiserspaytobedisplayednexttoparticularsearchtopics.EverysearchenteredintoGoogletriggersanautomaticauctionusingadvertisers’pre-bids,leadingtohundredsofmillionsofauctionsaday.4Advertisementsarerankedaccordingtotheirpopularityandonlysecondarilyaccordingtotheamountthatadvertisershavepaidinabidtokeepusersofthewebsitesloyal.However,advertisementswhichwerebidhighbutthenplacedinalowpositiononthepagewillpaylessthantheirbidamountperclick.4InadditionGoogle’sAdSenseschemeisbeginningtodisplayadsonthirdpartyaffiliatewebsitesdirectlyandsplittheadvertisingrevenuewiththewebsiteowners.9Affiliatewebsites,calledGoogleNetworkmembers,includeblogswhichareamateurcommentarieswrittenontheWebbyindividuals.Someofthemostpopularblogscanbevieweduptoamilliontimes(hits)adaybypeopleinterestedinthespecifictopic.Advertisementsareplacedaccordingtotherelevancytoeitherasitesearchortheactualcontentontheaffiliatewebsite.Thisenablesadvertiserstoreachverytargetedaudiencesandalsocreatesthepotentialforsuccessfulself-fundingamateurwebsites.ThetargetingpotentialcouldmakeAdSensemoreappealingtosmalleradvertisers.However,theprofitmarginislowerforAdSensethanAdWordsduetothesharingofrevenueswithNetworkmembers.4AlsoGoogleSearchApplianceservicewhichlicensesGoogletechnologytoenablecorporationstoeffectivelysearchtheirinternalwebsites.Googleisfocusingondevelopingrelatio
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