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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.
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.
2004: An IPO is Announced
Set for August 2004
Dutch Auction:Investors submit bidsBids are ordered, price sets supply =
demandAll investors get the same price
April 2004: S1 filing with SEC
1999 2000 2001 2002 2003 2004Q1
Revenue 220 19,108 86,426 347,848 961,874 389,638
Income (6,076) (14,690) 6,985 99,656 105,648 63,973
Per share (0.14) (0.22) 0.07 0.86 0.77 0.42
Diluted (0.14) (0.22) 0.04 0.45 0.41 0.24
How to forecast the rest of 2004?2003 2003Q1 2004Q1
Revenues 961,874 178,894 389,638Income 105,648 25,800 63,973Per Share 0.77 0.20 0.42Diluted 0.41 0.10 0.24
(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
Google vs. YahooGoogle 2000 2001 2002 2003 2004 (actual)
Revenue 19,108 86,426 439,508 1,465,934 3,189,223
Net Income (14,690) 6,985 99,656 105,648 399,119
Per Share(d) (0.22) 0.04 0.45 0.41 1.46
Yahoo 2000 2001 2002 2003 2004 (actual)
Revenue 1,110,178 717,422 953,067 1,625.097 3,574,517
Net Income 70,776 (92,788) 42,815 237,879 839,553
Per Share(d) 0.06 (0.08) 0.04 0.18 0.58
How do they compare in terms of revenue?
How do they compare in terms of profitability?
Pricing Google with P/E Ratios
Assume Google is just like Yahoo in 2004Yahoo shares sold for around $30Yahoo 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
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
What should you bid?
$76 based on 2004 information?
$120-$261 based on 2005 information?
Google’s “guidance” of $108-$135?
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.
What happened after 2004?Google Yahoo
2004 256% 222%
2005 243% 121%
2006 98% -22%
2007 34% -10%
2008 21% (est) 45% (est)
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 15th largest company in the US by market capitalization.
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.
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.
Step 1: Estimate the cash flows
Year FCF Growth
2005 100%+
2006 100%+
2007 100%+
2008 ~90%
2009 ~70%
2010 ~55%
2011 ~44%
2012-2018 Down to Below 10%
2019 on 3%
Year EPS(d) Growth
2005 243
2006 98
2007 34
2008 21 (est)
Business Week, 2004 Actual
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
Handling the terminal value
Pick a growth rate (5%, 3%)
Value as a perpetuity
Discount to the present
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%
Step 3. Present Value
E0= 1.46R= 0.174g= 0.05
Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20141 2 3 4 5 6 7 8 9 10
Growth 243 98 34 21 15 10 5 5 5 5Earnings 5.01 9.92 13.29 16.08 18.49 20.34 21.35 22.42 23.54 24.72 Terminal Value
109.97 4.27 7.19 8.21 8.46 8.29 7.77 6.95 6.21 5.56 4.97 42.09
Sensitivity Analysis
Base price = $110
g = 0.03: price = $103
R = 0.15: price = $140
R = 0.10: price = $298
How do the values compare?
Actual price: $85 - $198
P/E estimates: $76-$261
DCF estimates: $103-$298