Monday, January 09, 2006

Google Analysis - Part II

In earlier notes, we analyzed Google profit growth and compared its growth rate to other internet companies. The links to the previous articles are noted below:

Analyst upgrade of Google

A tale of three stocks - Google, Yahoo! and Microsoft

In this section, we will look at Google's profit margins to see what kind of leverage it has against Yahoo! and Microsoft in case the search wars intensify.

Googles income as percentage of revenue before income taxes is steady in 2005 between 34 and 35%. Yahoo! has income from operations of 18.9% before including other income and income taxes in the last reported quarter in 2005. Microsoft on the other hand is the most profitable business of the three with 46.7% of the revenue translating into income in its most recent quarter. It is interesting to note that Google's profitability declined from 2002 from about 42% to its current rate of 34%. The decline is most likely related to increased headcount costs in Google.

What do these numbers mean regarding competition moving forward? It gives us a good picture of the business - how well a business can convert one dollar in revenue to net income. In other words, one can measure the efficiency of a business.

Inspite of Microsoft having several newer businesses not pulling their weight and some losing money, it generates 3 billion dollars in free cash flow every quarter from operations. Google is generating about 400 million free cash flow from operations and the rate is expected to grow significantly in the next couple of years. Yahoo! is generating about 172 million free cash flow from operations, a distant third compared to Microsoft. However, Microsoft's MSN division that competes with Yahoo! and Google is not doing as well with profit margings of 15% and income of ninety million per quarter on revenues of six hundred million.

The mix will be interesting if Yahoo! is bought out by either Google or Microsoft. Yahoo! has several things to offer to either companies. Yahoo! mail is better than Googles and Yahoo! offers content. Google can benefit immensely by buying Yahoo! Microsoft's internet unit has less to gain from the acquisition as there are lot of comman services between MSN and Yahoo! in terms of what they offer. Microsoft just has to focus on improving its web services to remove clutter and make it easy to use to compete with Google. Google still leads the pack in its ability to monetize its different offerings. Microsoft has cash to burn and expect it to spend some of its cash from Office and Windows businesses to compete with Google.

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