 By Silicon
el 18-Apr-2008 |
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 After Google's $75 post-earnings pop, it's time we checked on valuation again.
We value Google (GOOG) using free cash flow (see below). The bad news in the quarter was that Google's capital expenditures soared to $842 million, which depressed free cash flow (only $937 million in quarter, down from more than $1 billion the past two quarters). But we're optimistically going to assume that this massive increase in CAPEX won't continue forever and that Google will generated about $4.5 billion of free cash flow this year.
How's Google trading relative to that? At $530, it's trading at 35X FCF. That's a bit higher than we think it should be given then rapid deceleration of Google's US and UK businesses, but its certainly not insane. Unless free cash flow gets hammered, we continue to think the stock has a valuation floor around 25X (the long-term power of the franchise is just too compelling
for investors to completely throw in the towel).
Free Cash Flow vs. EBITDA and P/E
Why do we look at free cash flow instead of EBITDA or Earnings? We
find Google's non-GAAP P/E less meaningful than it would otherwise be
because of the significant percentage of option cost that the company
is still expensing (which most analysts ignore).
EBITDA, meanwhile, is a meaningless metric for companies that have
significant capital expenditures, which Google now does. (Wait, do we
mean EBITDA is a meaningless metric for the entire media and cable
industry, which clings to it like a crutch? Yes, we do! We suspect "EBITDA"
was invented by brilliant early cable industry titans who hoodwinked
analysts into thinking that cash-flow-before-required-expenses was
meaningful. It isn't.)
Will Google's FCF Get Crushed?
If Google's revenue flattens (or, God forbid, drops), will FCF get
slammed? It might, especially for a couple of quarters. We believe,
however, that Google's huge capital spending in recent years has been
the direct result of having operating cash flow coming out its ears. If
operating cash flow shrank, therefore, we believe Google would be able
to significantly cut back on CAPEX, thus preserving cash flow.
Going forward, moreover, as Google continues to grow (perhaps on the
other side of a recession), we think there's room for CAPEX to decline
as a percentage of revenue. This would allow FCF to grow far faster
than revenue.
Bottom line, we don't think Google's free cash flow margin is a
"peak margin." We believe the company has been spending like a drunken
sailor. If times get tough, we think the company would be able to cut
back, thus boosting its FCF yield.
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