Wednesday, February 02, 2005

GOOGLE GETS IT--DOES AOL-TWX?

AOL announced this week that they will suspend their usenet group chat-rooms. GOOG has added a "groups" button to its home page. Billions of postings are made in these group "rooms" by millions of users annually. It is easy to search GOOG and find an on-going discussion about most any topic you want. Anyone can set up a free group site and "get-together" to discuss any topic you like. A Sunday School Class can set up a group and invite only the class members to participate it can choose to change the settings and invite all to join. The sites are free to set up and free to use.

The cost to GOOG to host these "message boards" are miniscule. It also cost GOOG almost nothing for its computers to scan the words posted and then post relevant ads along-side. GOOG gets another trillion "bill boards" at minimal cost. I view hundreds if not thousands of GOOG "bill boards" daily. I do not click on an ad very often but when I do, GOOG gets paid.

After GOOG's huge fourth quarter, it has been fun to watch analyst adjust their earnings estimates for next year. The company increased its earnings for the fourth quarter from $.10 to $.71 ($.95 if you don't include one time charges)! The increase is better than 600%! Revenues for the quarter jumped to $1 Billion.

One CNBC anchor babbled this morning about the possibility of $3.95 earnings for next year. I will not suggest that earnings will go up 600% again but $3.95 for the year is only 4.15 times the $.95 for the forth quarter. If the earnings were to double .95 for the next four quarters the annual earnings would be $7.60. I admit that the current stock price is 28 times $7.6. The stock is not cheap in terms of Price to Earnings or other valuation metrics, but only a couple more years at 600% increases would make the stock extremely cheap (.7 times earnings?). It is clear that the growth potential for this company is still not understood by most investors.

AOL GETS IT TOO!
Ironically, I believe TWX is a good buy at today's price. The move to get out of the group-chat business shows wisdom. When a boxer finds that he is consistently beaten, he needs to step out of the ring. GOOG is beating the pants off any and all comers. TWX has gradually regained its focus.

TWX has tremendous assets (second largest cable company, Time magazine and about 250 more magazines and a top movie studio to name a few) and, again ironically, advertising revenues are set to increase for the next several years. With hundreds of magazines, TV, movie and web outlets, TWX will see significant growth. This company has seen its price to sales ratio decline from 3.7 to 2% in the past 3 years. This is one of those profit opportunities where the value of the company has gone up while the price of its stock has gone down. The company clears nearly $7 billion dollars positive cash flow per year. It has been reinvesting about $3 Billion per year and it has been paying down debt.

The company has numerous choices available for expansion. It is adding revenues through VOIP services and is signing up significant numbers of broadband subscribers. It is bidding on the assets of Adelphia, the large bankrupt cable company headquartered in Philadelphia. The word is that TWX will bid to buy 3/4ths of the company and Comcast will buy the other quarter. The TWX bid is for $17 Billion.

There has been a lot of writing off and writing down for the past several years. This means that the current earnings are really good earnings; no fancy accounting here (the SEC has taken them to task for cooking the books prior to the merger).

GOOG and TWX make for interesting comparisons.

The total value of all shares of Goog (market cap) adds up to $57 Billion. The total value of all the shares of TWX add up to $83 Billion but TWX has debts of about $33 Billion. The money GOOG makes belongs to the share holders but TWX must first pay the bond holders. This means that the total enterprise value of TWX is $116 Billion. TWX is about twice the size of GOOG on this measure. Based on revenues TWX is about ten times the size.

TWX is selling at only 1.4 times book value and it has some valuable properties that have been depreciated. The buyer of TWX is getting hard assets for his money. GOOG sells for 20 times book value! The value of this company is largely an intangible value. It has a large profitable business that is growing very rapidly whereas TWX has a larger profitable business; however, one of its biggest cash contributors, AOL dial up, has declining revenues. Put another way, TWX has $41 Billion of slow growth--low margin sales and GOOG has less than $4 Billion of high growth--high margin sales. TWX got a return of 2.6% on assets last year while GOOG got a return of 21%.

If you assume through a leap of faith that GOOG will grow its revenues at 30% for the next eleven years and TWX grows slowly, then GOOG will have caught up in revenues by 2016. One must assume that profit margins will have declined significantly by then but under these circumstances GOOG would be the more valuable company.

If you are a true believer and think that GOOG can increase revenues at 35% per year, then GOOG will have about double the revenues of TWX in 11 years. Profit margins will have shrunk but could still be healthy making GOOG worth several times the value of TWX.

It is pure folly to forecast 11 years out. I have gone through this exercise to try to demonstrate the faith one must have to buy a stock like GOOG that is selling at about 55 times its most recent anualized earnings. It is easier to sleep at night owning TWX. If you want the excitement and the steady earnings you should consider investing equal dollars in both companies and hanging onto your hat.




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