Google Analysis

Google, Inc.

Overview

Google is a global technology leader, focused on improving the ways people connect with information. Through innovations in web search and advertising, Google is now a top Internet destination and possesses one of the most recognized brands in the world. Available to anyone with an Internet connection, Google maintains the world's largest online index of web sites and other content.

Revenue is generated by delivering relevant, cost-effective online advertising. Businesses use the Google AdWords program to promote their products and services with targeted advertising. Furthermore, Google maintains advertising on thousands of third-party web sites using the Google Network and Google AdSense.

While Google continues to expand its product line into new and existing territories, the company considers its primary industry to be web search technology. However, Google also faces competition from online advertising companies, particularly those that provide pay-per-click services. Currently, Google considers its primary competitors to be Microsoft and Yahoo.

Future operating performance will be directly related to the role of information technology in the marketplace. Information technology is an area experiencing constant growth and innovation, which existing companies must address in order to overcome product obsolescence.

A variety of factors exist that will affect the success and future growth of Google. First, Google must protect its proprietary search algorithms accounting for its success to date. If such methodology reaches competitors, its competitive advantage is suddenly lost. In addition, it must be able to maintain its competitive advantage over Microsoft in areas of expertise. Microsoft is a proven industry leader in many aspects of technology, having the financial strength to compete in every capacity.

Key Accounts

The growth in revenues that Google is experiencing is astonishing. However, all of its revenues at the moment are the direct result of two business segments. The two primary sources of revenue are Google owned sites and the Google network, each accounting for approximately 50% of revenues (Exhibit 6).

For this reason, the cost of revenues becomes a key account on its income statement. As demonstrated in the vertical income statement, the cost of revenues rose from 11.46% in 2002 to 45.71% in 2004 (Exhibit 3). This is ideally due to traffic acquisition costs (TAC) that Google incurs as it drives consumers to its sites. While these costs have been rising relative to sales, the company believes that its future success will be a result of its increased knowledge in effectively and efficiently generating traffic. As illustrated in Exhibit 6, quarterly revenues increased significantly throughout 2004, while traffic acquisition costs as a percentage of revenues began to decline.

In addition, the financial statements demonstrate that liquidity remains strong. The horizontal balance sheet illustrates that cash and cash equivalents rose 639% over the three-year period beginning with fiscal year 2002. Furthermore, short-term investments increased 1839% over the same period (Exhibit 2).

These measures are important for a variety of reasons. As Google attempts to become the front-runner in the web search and online advertising industries, it is beginning to face considerable litigation regarding its advertising policy. Paris courts recently reached a decision surrounding this issue and luxury goods maker Louis Vuitton (Exhibit 7). Secondly, as the marketplace witnesses the current success and growth of Google, it is inherent that more competitors will emerge. These companies may draw interest in terms of acquisition from Google, potentially complementing current operations. Strong liquidity will allow the company to handle the presence of lawsuits and the ability to fund such acquisitions without the need for additional capital through debt or equity financing.

Financial Ratios

The company providing financial ratios in this analysis, Rueters, uses the "Computer Services" industry as a basis for comparing Google to industry standards. Overall profitability is slightly lower when comparing net profit margins. For fiscal year end 2004, Google reported a net profit margin of 12.52%, slightly lower than the industry's 13.45%. It appears that this is largely due to the elevated effective tax rate that pertains to Google, as the company's operating margin is actually superior to the industry average (Exhibit 5).

Two financial ratios will prove very important over the next several years: gross margin and return on assets. As mentioned earlier, cost of revenues increased significantly over the past 3 years. In turn, the gross margin percentage began to decline as well (Exhibit 3). For fiscal year end 2004, Google reported a gross margin of 54.29%, significantly higher than the industry average of 45.93% (Exhibit 5). This becomes particularly relevant when considering that Google is still in adolescent stages of efficiently generating traffic to its web sites. If Google can prove more efficient in this area, cost of revenues would decline, leading to a more dominant gross margin relative to the industry.

All companies in the technology sector experience high costs associated with asset acquisition. Google operations require a continuous investment in information technology assets to handle additional traffic. For this reason, Google must continue to demonstrate a strong return on its assets, justifying such expenditures. For fiscal year end 2004, Google reported a return on assets of 12.05%, slightly higher than the industry average of 11.03% (Exhibit 5). This return has declined considerably, around 22.7%, over the past three years (Exhibit 4). Much of this decline is likely due to the increase of nearly $71 million in intangible assets over the three-year period (Exhibit 1). While this figure seems very large, it may actually be reasonable. While the brand name Google is becoming synonymous with web search technologies, the company is now acquiring smaller ventures that complement its current services. They are also developing numerous revolutionary technologies that should arrive in the marketplace over the next