Before the meteoric rise in the price of Apple (click ticker for report: ), Google (click ticker for report: ) stole most of the tech-stock headlines and, according to some, was pretty much a sure bet to become a $1,000 stock. However, looking under the hood, the company has had some turmoil during the past few years.
In addition to bringing back founder Sergey Brin as the CEO, the company has created the world’s most successful mobile operating system to date (Android), a social network with over 100 million users, and failed to purchase Groupon (click ticker for report: ), which at the present seems like it was a blessing. Additionally, the company is working on cars that drive themselves, shuttered Google Wave and the “Twitter killer” Google Buzz. And it bought Motorola Mobility. All of these events have made Google a much different company than it was even a year ago.
Once known exclusively for its search dominance, which it maintains, Google has become a tech company focused on a number of things: social, Android, ads, YouTube, Chrome, and research. In this article, let’s dive into a few markets that we think will decide the future of Google. We think the company will have some megahits in the years ahead, and the shares are worth over $900 each, in our view, revealing substantial upside from current levels.
Android
Giving away one’s mobile operating system certainly isn’t as profitable as selling one (at least in the short term), but Google is betting that stealing market share will inevitably lead to dominance, which it will be able to exploit later. That strategy has made the Android OS (operating system) the most used mobile operating system in the world, with Apple coming in second and Blackberry (click ticker for report: ) now a distant third. However, we think the open source code of the Android OS may lead to lower retention rates.
But lower retention rates for its system may not be totally Google’s fault, as the problem may actually lie with the hardware manufacturers. HTC, Samsung, LG and Motorola all use the Android OS, but the experience differs across producers. Further, the actual quality of the hardware is inconsistent, and users don’t have the option of going to the Apple store for repairs and refunds. Interestingly enough, we’ve seen a shift in the Android market to consumers primarily purchasing the luxury phones like the Galaxy SIII and the Note.
In earlier research, we noted that we expect retention rates for Android to be lower than iOS (Apple’s operating system). We think iOS will likely become the leader in market share in the US. However, since most carriers do not subsidize phones like carriers in the US, it looks like Android will dominate global market share due to lower average selling prices on smartphones. Rumors have surfaced that Apple may try to build a cheap phone to compete, but we think they’d rather lose market share than put downward pressure on margins.
Furthermore, Android has yet to penetrate the tablet market. The iPad is the dominant product in that market and Gartner estimates that iPads accounted for 73% of all tablet shipments in 2011:
While RIM and Microsoft (click ticker for report: ) have yet to pose a competitive threat, we don’t see Android tablets gaining the market share or stickiness of the iPad. Amazon (click ticker for report: ) has also come out with a tablet of its own, undercutting the vast majority of the market given the quality of the product. But because the iOS interface is the same across all Apple devices—an intuitive experience across all Apple platforms—we think it’s easier to keep users in the Apple ecosystem than the Android ecosystem. We fully expect Apple to retain its dominance over Android.
Google+
With over 100 million members, one would think Google+ is a thriving social network. However, that doesn’t seem to be the case. The April 9 issue of Bloomberg Businessweek revealed that users spend an average of 2.5 minutes per month on Google+ versus 7.5 hours per month on Facebook.
Admittedly, Google+ has several cool features unavailable on other social networks like hangouts, where you can web-chat with a group of friends, and circles, which allow you to decide who you share your posts with. But features don’t create a social network, networks do.
Twitter and Facebook (click ticker for report: ) can both co-exist because they serve different roles. Facebook is more personal, and allows you to interact with all of your friends, share all of your photos, and keep-in-touch (without actually keeping-in-touch). Since several users have had their Facebook pages for around five years, Facebook acts as a digital time capsule that literally cannot be replicated. Its network effect is dominant.
On the other hand, Twitter is a real-time information site. Instead of searching for a something on Google, several users now go to Twitter, which doesn’t have the time delay that Google and Bing have. Additionally, users can interact with millions of users from all over the world. There’s currently no other forum where prominent actors, athletes, pundits, and even traders interact with each other so quickly and efficiently.
Google+ combines some features of Twitter, such as the ability to interact with massive amounts of strangers, and the ability to archive memories like Facebook. However, since the network lacks, well, the network of Facebook and Twitter, such features fall on deaf ears. Unlike Facebook or Twitter, where one must consciously go through the sign-up process, Google+ takes two minutes for users with Gmail accounts. Thus, we think the actual new user base is significantly smaller. We aren’t very optimistic about the future of Google+ at this time.
Search
Although we aren’t particularly bullish on Android or Google+, let’s not forget about Google’s search/ad business. Though Bing seems to be gaining market share, which Forbes estimates was at 15.1% at the end of 2011, Google still dominates, with 66% of the search market. Adsense still generates the vast majority of Google’s high-margin revenue.
Much like social, we think Facebook and Twitter are bigger threats to search than Bing or Yahoo!. Facebook and Twitter are getting so good at dominating users’ time spent on the web that companies now post their Twitter handles or Facebook pages on commercials and in stores, rather than their own websites. We think companies prefer the real-time feedback and interaction provided by the likes of Twitter and Facebook. The big risk for Google is that Internet users bypass Google and go directly to Facebook and Twitter to search for what they want. Search functionality might be mediocre on Facebook, but remember that Microsoft owns nearly 2% of Facebook and could lend some of its search technologies to improve the user experience.
It also appears that mobile ads are stealing market share from desktop ads, but mobile ads seem to lack the same ROI and aren’t nearly as effective as desktop ads. Facebook reported fantastic increases in mobile ad sales, and we see Instagram as another potential mobile revenue driver. Google will have to focus on innovating in the mobile market in order to stay relevant to advertisers looking to reach consumers via smartphones and tablets.
However, it’s important to remember that Google does–and will likely continue to–dominate the rest of the web. Adsense is still among the top advertisement products in terms of ROI (return on investment), and its share is dominant. We think this will continue to fuel Google’s profitability.
Research and development
If there’s one area that could propel Google far above our fair value estimate, we think it lies in research and development. With an army of engineers and brilliant computer scientists, we think some amazingly innovative products could come out of research and development (R&D) at Google.
Project Glass was released in early April, and while it may not be for everyone, it’s certainly exciting:
Glasses that allow you to control social networks, search, and take pictures all-in-one seems more like a sci-fi fantasy rather than a possible reality. But Google is working on it.
The self-driving car and other projects
In Google’s home state of California, the company recently won government approval for testing cars that drive themselves. Though the idea seems dangerous, Google and several automakers contend that cars driving themselves may be the way of the future (we can’t forget that airplanes didn’t always have autopilot). If this becomes the new standard in driving and Google is responsible for the technology, the company could profit handsomely.
Google Fiber is another project that could be a game-changer in the internet realm. The test city is Kansas City, where the company rolled out its internet fiber optics network. Speeds top 1GB per second (or 100x faster than the average Americans internet connection), and the company offers tiered pricing up to $120 per month. Initial feedback looks positive, and we think Google will slowly build out networks nationwide if demand surges in Kansas City.
We can’t be sure that anything in the R&D department will be a success, but owners of the stock do get the added benefit of any unforeseen innovation that may not come with owning mature entities such as McDonald’s (click ticker for report: ) or AT&T (click ticker for report: ), for example.
Google’s valuation
We think Google’s shares look undervalued, even though fears of mobile-advertising acceptance have weighed on the company. We don’t expect mobile or Google+ to propel the company to higher profitability, but we think the firm will likely maintain market share on the traditional web for a very long time. Mobile ads aren’t quite what PC ad sales were in terms of ROI and cost per click, but we think Google will adjust. Given the innovative nature of the company, we wouldn’t be surprised to see Google as a leading glasses maker, car-software innovator, internet provider or anything else in the next ten years. We continue to hold the company in the portfolio of our Best Ideas Newsletter.
A version of this article appeared on our website April 12, 2012.