Sunday, December 18, 2005

A tale of three stocks

In the internet search space there are two companies that can give Google a run for its money. They are Yahoo! (ticket YHOO) and Microsoft (ticket MSFT). Microsoft has invested heavily to improve its search offering and is adopting the look and feel of google in its windows live and office live webpages. Yahoo! has been one of the earliest internet companies and has also improved its search and other product offerings to compete better with google. In this segment, we analyze the three companies and look at the revenue trends and how should one invest for the coming six months to a year.

Let us first look at Google. In the most recent quarter( sept 05) - Google has revenues of 1.578 billion and up 14% from last quarter. It earned 529 million dollars. The google revenues are up 94% compared to last year. The run rate gives an estimate of about 70-80% growth for next year's revenues. Even if the stock price doesnt move much from where it is today - the P/E next year around this year would be 56. It is likely that Google earnings growth will slow down to 50-60% run rate at this time next year.

The second company in the mix is Yahoo! Yahoo has had a good run the last year but the rate of increase in revenues is slowing down. It is still growing quarter over quarter - the next year, the growth rate would be around 30-35% compared to this year. The Yahoo! stock price - it it doesnt move further will be around 29 at the upper end. The earnings rate for Yahoo! is also likely slow down further to about 15-20% in 2007. The quarterly revenues by Yahoo is 1.3 billion an increase of about 46% over last year.

The third company in the mix in Microsoft. Its MSN division is the third party to the race. The MSN revenues are down about 8% quarter over quarter and are slightly up at 1% year over year. Even though Microsoft has heavily invested in to search, the results are not showing up in the balance sheet. The quarterly earnings from the MSN division is stagnant around 580 million dollars per quarter.

What are the different things going in favor of different companies? Let us look at google, yahoo and microsoft and see how things look.

95% of google's revenue is through advertising and search. Google has moved quickly to monetize its mail program through advertising. The challenge for google in the upcoming years is to diversify more into other revenue streams before other companies start to copy its format and offer advertising. In the next couple of years, growth from search is likely go down a bit on a year over year basis.

Yahoo is already well diversified with different revenue streams such as providing marketing service to busisnesses, search and information for individual users and communication and consumer services. In the most recent quarter, Yahoo!'s retained earnings were 270 million dollars compared to Google's 550 million. While Yahoo! has upgraded its search and its e-mail service is good, it doesn't have Google's momentum. Also - Yahoo! is incurring higher costs to provide the various services it is providing compared to Gooogle.

Microsoft's MSN division is a distant third in the race. Accoriding to Microsoft's earning reports, the MSN division made 89 million dollars on revenues of 564 million in the most recent quarter. The MSN division is struggling as the revenues from dial up lines is drying up and its MSN portal site remains large and clunky. The MSN portal is more like AOL in many respects. The MSN search technology has improved significantly. The new windows live and office live offerings are a step in the right direction. Although Microsoft doesnt have momentum currently - it is a tough competitor and the next couple of years should show if it can reverse its current trend.

Given the trends - the pecking order is clear - it is Google, Yahoo! and Microsoft. It is unlikely the trend will change in the next three - six months. Google is richly priced for its potential and is likely to meet/beat the earning estimates in the next couple of quarters. Yahoo! likewise is richly priced for its growth which is likely slow down further the coming year. Microsoft is a wild card, it is unlikely Microsoft will give up in the search space irrespective of the results. Microsoft has done well when it has focussed in the past - it is likely to gain on Yahoo! and Google in the next couple of years. Although it is difficult to see Microsoft becoming the numero uno in the next couple of years - it is likely to give tough competition for the number two spot.

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