Since February 2013, Google has significantly outperformed Apple and the S&P500 index, with Google up 46.4 per cent while Apple has risen only 13.3 per cent and the S&P500 index 18.4 per cent. Whilst Google is no doubt performing well, there is still a long way to go. Below we highlight a couple of basic assumptions regarding the secular shift to online advertising that could see Google become the world’s first company to have a market capitalization of over US$1 trillion by 2020.
Total advertising spend globally is expected to grow to around US$720 billion by 2020 (in line with World GDP growth). In the online space this growth is likely to be even faster as advertisers continue to align advertising dollars with consumer habits. The chart below shows that in spite of the explosive growth in the time spent by consumers online and increasingly also on mobile platforms, advertising dollars have been relatively slow to follow.
If we assume that growth in digital advertising continues to grow in line with media consumption habits to 36 per cent of all advertising spend by 2020 (from 22 per cent today), then this would represent 13 per cent p.a. growth in Google’s core market to $260bn by 2020. Assuming Google can grow its market share of this market to 50 per cent from 45 per cent today, core Google search could command $130bn p.a. in gross revenue.
You Tube and Android
Adding to the above opportunity, Google has further growth avenues via its YouTube and Android businesses. You Tube is going after TV advertising budgets, which still remain the dominant category for advertising spend globally. YouTube is the largest online video site globally and as such is uniquely positioned to drag advertising dollars away from TV. It’s currently estimated that YouTube has captured just 1.8% of the current $230bn plus global TV advertising budget. If this were to increase to 6 per cent by 2020 this would represent a further $20bn revenue opportunity for Google. Adding to this success is Android, the mobile phone operating system Google gives away free to “smart phone” manufacturers including HTC, Samsung and Sony. Google benefits from users being directed to Google Search and Google Maps, but also via users being directed to the Google Play store which sells apps and where Google earns a commission. Android has grown from essentially zero users 4 years ago to over 1 billion now. Assuming continued growth in activations and US$5 in revenue per device via downloads from the Google Play store, this represents another US$12.5bn revenue opportunity by 2020.
So how do we get to $1 trillion?
Adding these core revenue drivers together and subtracting traffic acquisition costs, we estimate that Google can achieve US$130bn p.a. in revenue by 2020 (a 15% p.a. growth rate from around $50bn net revenue today). This should equate to roughly $65bn of EBITDA in 2020. Rolling that forward one year and applying the same 12x EV/EBITDA multiple that Google trades on today, achieves an enterprise value of $895 billion by 2020. Add back the estimated $120 billion in net cash that the group is expected to have accumulated by 2020, we arrive at a market capitalisation of over $1 trillion. Google’s current market capitalisation is US$343bn with US$60bn in net cash. Our estimates represent a 260 per cent rise in the share price over the next 7 years.
While clearly the actual outcome is likely to be different from the expectations above, the assumptions used are not aggressive for a company with a dominant position in an area of strong secular growth that will benefit from improved earnings largely independent of economic conditions. The bulk of Google’s growth will come from consumers shifting to online media, a world which Google dominates now and is expected the company will extend its dominance in the future.
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Source: K2 Asset Management, February 2014