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A Casual Stroll Down Tech Valuation Lane – Facebook, Apple, Google, and More

by Brett on January 17, 2011

Facebook’s alleged $50 billion valuation granted by Godfather Goldman really has had the investment community aflutter.  ”A social networking bubble!” proclaimed value investors around the globe.

But is this a fair claim?

On the heels of news that Apple has passed energy giant ExxonMobil to become the world’s second most valuable company, why don’t we take a step back and look at the big picture with regards to our favorite tech companies.

Which are overvalued?  Is this another bubble?

Are there any tech stocks that are – dare I say it – undervalued?

When it comes to technology, you really have to look past the obvious fundamental valuation metrics.  Multiples on sales, earnings, and cash flow are OK places to start, but used alone they’ll lead you astray.  Instead, we need to peer through the fog (as tech hedge fund legend Andy Kessler says) and figure out who will be the big winners of tomorrow.

Because today (not to mention the last quarter) is old news.  The stock market is a forward looking vehicle – which is hard enough to gauge when it comes to “old economy” companies with fairly static markets and cash flow prospects.

It’s especially tricky when we look at the tech sector, where someone is always eating someone else’s lunch, and the untouchable stalwart of today (ie. Microsoft circa 2001) is the fading dinosaur of tomorrow (ie. Microsoft circa 2011).

Also I make the assumption, when looking at technology stocks that have a lot of analysts covering them, that their stock prices are relatively efficient and have most of the “known knowns” priced in.  Hence, we are going to attempt to peer through that proverbial fog, to see where there may be pricing inefficiencies as we speculate how the next 5 or so years may unfold.

So please join me as we take a stroll down technology valuation lane.  Equipped with only a pen and back of an envelope (because software hasn’t managed to do better than this, yet), let’s map out the rough prospects for the tech stalwarts of today going forward, to see where potential values (and overvalues) may lie.

Google

The Almighty Google is the reigning King of the Internet, and hence, King of the Universe.  Google controls the internet because it owns Search.

When most people look for something on the internet, they navigate to Google’s homepage and type their query in the search box.  Some people use Google for everything – and I mean EVERYTHING.

For example – I see this on customer support calls all the time – when I tell the person I’m on the line with to type in a URL, there are many people who are in the habit of typing URL’s directly into Google’s search box (rather than the URL line in the browser itself) – now THAT’s lock-in!

Google makes its money – or really, prints vast swaths of it – by running relevant ads based on the search terms that are typed in.  If you click on one of those ads, the advertiser pays Google for the click.

The Google” has tried to “get wide” with its product offerings and serve up other free products that will keep you further locked in to their world – so that you’ll keep using them for search.  Some have been more successful (Gmail, Google Maps) than others (Google Buzz anyone?).

Ultimately they want to serve up relevant ads to you anywhere and everywhere.

A brilliant play by Google was the Android phone – which essentially turned the smart phone sweepstakes into a two horse race.  With the Droid, Google is able to get you hooked on its stuff (instead of drugs, Google peddles apps – cocaine is soooooo 20th century).

And of course, the Droid’s default search engine is Google’s own.  So that when you search for something from your phone, Google can serve you up…Google Adwords!

The “hook” worked for me personally – within a couple of months of getting my Droid, I finally switched from Outlook to Gmail (which happens to integrate seamlessly – go figure) and the rest was history for me.  I became a full fledged Google App fanboy.

So is GOOG cheap?  Expensive?  I’m inclined to think it’s priced more or less appropriately – by the aforementioned smart people who crunch Google’s numbers all day.

Other than the late ‘08 panic, Google has been more ore less rangebound:

Google stock price chart 2011Source: StockCharts.com

With a market cap of just under $200 billion, there’s not a ton of upside available – as trees don’t grow to the sky.  Yet as long as people start their internet experience with Google, Adwords will keep humming, and this cash cow should provide reasonable enough support for Google’s stock price.

Couple that with the anticipated growth that Search should continue to see with more of Earth’s inhabitants connecting to the internet, and things look pretty good.

So is there anything that could possibly trip up the Google juggernaut?

Facebook

Believe it or not, Google is utterly terrified of Facebook.  Because Facebook is the one internet site today that could “head off users at the pass” when it comes to their internet experience.

Remember what AOL used to mean to its users in the mid-late 90’s?  It was their gateway to the internet.  Instead of being faced with a random browser homepage and confusing address bar, users were greeted at AOL login by their very own concierge (perhaps a poor man’s concierge, but a help nonetheless) to assist them in their next move.

Want sports information?  Click here.  Finance?  Click here!

And this “dummy proof” form of navigation is still the preferred method of surfing the net for your average internet user.  (By the way, if you’re reading this article, you are WAY more sophisticated than the average internet goer. :) )

Back to Facebook.  You go to Google when you need to find something.  But let’s assume that Facebook becomes your default “go to” site – you chat with your friends there, send messages back and forth (perhaps replacing email), and because Facebook knows everything about you (because YOU told it!), it can basically anticipate your next move.

No need to search Google, because Facebook is your new Mother Hen – it knows you better than you do!

And if you think Facebook’s appeal is limited to teenagers and college kids, you’re greatly underestimating it.  It’s already broken into the mainstream, and you’re just as likely to see a stay-at-home mom living on Facebook these days as you are to see a college kid.

While Facebook’s reported latest $50 billion valuation may have been a misrepresentation, let’s say, for the sake of argument, it’s around $30 billion.

This would still represent a “breakout” – a new all-time high – in Facebook’s valuation.  The chart would be going from the lower-left to the upper-right relentlessly – no question the trend is up.

And at $30 billion, Facebook is quite a bit cheaper than Google at $200 billion.  And for a company with a better than puncher’s chance of “owning the internet”, that may not be a bad value relatively.

Plus, Mark Zuckerberg has proven himself to be at least a very good product guy.  In the technology world these days, the best product usually wins (best marketing stopped winning about 10 years ago – see Dell).

I would never sell short a good product company, or good product CEO.  Speaking of which…

Apple

Is probably THE best product company on the planet right now, led by one of the greatest product CEO’s of all-time.

Yes, everybody knows this.  Yet, everybody knew this when Apple broke $200, and the stock has continued its climb to the upper-right hand of the chart, thanks to it’s latest groundbreaking innovation, the iPad – a Jobs original that you’d have needed to peer through that fog to anticipate.

Apple stock price chart 2011Source: StockCharts.com

I love Apple’s position going forward, because it owns the devices you use to connect to the internet – the iPhone, iPad, Mac, and whatever Mr. Jobs comes up with next.

Because they’ve got you hooked in at the device level, Apple has the initial say on where you navigate to on the net.

This, also, is a BIG potential threat for Google, because if Apple so chooses, they could switch their default search engine over to Bing, or something else, and that’d totally jam up Google.  Somebody else would be serving you relevant ads!

Given Apple’s solid position, and excellent product CEO, their future looks quite promising.  But most of this is probably priced into the stock.  I’d neither go long Apple, nor short it, at this point – I don’t find the risk/reward compelling either way, as it, like Google, is probably roughly fairly priced.

Though being a great tech product company, if you’re going to take a position, go long!

One potential threat to watch is Jobs’ insistence on owning the entire user experience, soup to nuts.  Their platform is not as open as Google’s, which could end up hurting them.

But given that we’re looking at a two-horse race, with room enough for both to be quite successful, Apple should be alright with their more authoritarian product approach, provided Jobs doesn’t push the envelope too far (like he did in the 1980’s with the Mac).

Microsoft

What a difference a decade makes, huh?

Remember in 2002 when Apple was trading in the low teens, not far above the cash on its books?  This was before iTunes was released, and long before the iPod, iPhone, and iPad.

The Mac looked like it was dead in the water – permanently confined to the artistic class.

And Microsoft was Master of the Tech Universe!  Charging $299 a pop for their shoddy Windows OS – sure it was highway robbery, but what choice did consumers have?

Microsoft stock price chart 2011Source: StockCharts.com

And so we see in hindsight, once again, nothing fails like success – especially monopolies.  Microsoft continued to make its OS worse, its software worse – the more developers they tossed at a project, the crappier it’d turn out.

But, argued Microsoft bulls, at the end of the day, they still had a monopoly.

Perhaps they did – on 1990’s/2000’s computing technology, that is!  But a funny thing happened on the way to monopolistic heaven – and that, my friend, was the Cloud.

To the cloud!

Yes, the magical Cloud that Microsoft ads now boast about – you know, the ones that don’t ACTUALLY feature any software in the cloud – is the same cloud that’s leaving Microsoft in the dust.

Make no mistake about it, Microsoft is a complete disaster.  They have not been able to develop good software in many years.  They’ve continued to throw more and more developers at their products, which paradoxically is the WORST thing you can do when it comes to software development.

Because, building software is not like building a bridge, where more manpower can actually help.  With software, too many cooks in the kitchen can quickly lead to diminishing returns, and more likely, negative returns, for every extra coder you toss in the pot.

The cloud’s emergence is hurting Microsoft in two big ways:

  1. It’s making the desktop operating system obsolete – not good if you happen to have a monopoly on desktop OS’s
  2. It’s making software really easy to develop (and distribute, too)

Let me give you an example  near and dear to my heart – my software startup, Chrometa, built a very slick time management desktop/cloud combo app (if I do say so myself) with four guys.  Count ‘em: 1,2,3,4!

This is the future of software – get a few talented developers, and build a web app that solves a very specific problem.  Then, make sure you have an open API, so that your app can talk and exchange data seamlessly with other apps – which are likely built by other small dev teams.

GONE are the days when you need to throw hundreds of developers at a project – it’s now counterproductive!  It’d take Microsoft years to get our product past the drawing board alone.

They are just not well adapted for software development in the year 2011 and beyond, in my opinion.  You don’t need complicated specs and a huge dev team – you need one really good developer, and a market ready to validate what you built.  Then you iterate on feedback – which you can do quickly, because development on the web can move very fast.

By the time Microsoft has finished their initial specs, you’ve been able to iterate tens or hundreds of times on your app.  Ballgame over – the small dev team wins!

So while Microsoft’s stock may look cheap, it probably SHOULD be cheap.

It all went downhill when Bill Gates – the product guy – left the company, and started turning his focus towards saving Africa.  Not that there’s anything wrong with that…unless you’re a Microsoft shareholder.

After all – would you feel good about investing in a software company run by a socially awkward bean counter?

‘Nuff said on MSFT.

Intel

Like Microsoft, Intel looks dirt cheap to value investors.  But it’s cheap because it too has fallen behind the times – namely putting their vaunted silicon in the latest and greatest computing devices, tablets and mobile phones.

But unlike Microsoft, I think a punt on INTC may be an interesting speculation, as, based on history, they’ve got a decent shot at figuring this next act out.

Intel stock price chart 2011Source: StockCharts.com

Intel is making two bets going forward.  First off, they want to be the “backbone” of the cloud.  Intel wants (and needs) the cloud to run on Intel processors.  So far so good on that front – most of Google’s servers to run on Intel’s chips, for example.

This is why Intel purchased McAfee – it wasn’t for their crappy desktop antivirus software, but instead for the enterprise security inroads that McAfee has.

Security is a big issue in cloud computing – with everything now “out there”, people want to make sure some evil hacker can’t easily access their stuff.

Intel, in their purchase of McAfee, made a reasonably intelligent speculation that security in the cloud will remain an important issue going forward.

But providing processors for cloud servers has not been enough to keep Wall Street bullish on INTC – not with the PC market going “bye-bye” at a slow but steady clip.  Intel inside?  Not on tablets and smartphones.

At least not yet.  Intel management admits they were caught flat footed here.  But Intel is USUALLY caught flat footed on new stuff.

Their expertise is not in innovation (case in point: Intel’s joint venture with GE, Intel Health, was a complete joke that recently, mercifully, was spun off).

Instead, Intel’s expertise is in execution – building chips that are better, faster, and cheaper than the competition’s.  Intel watches how you do something – then they do it better than you, and take your lunch money in the process.

They don’t have a tablet chip presence – not yet.  But they did just announce a new tablet division last week, and they’ve got all the smart people internally flocking there.

So, while Wall Street yawns at Intel’s past record quarter - and rightfully so, as the future is cloudy for INTC – it’s reasonable to think that Intel may very well get this tablet thing figured out.

If they do, current investors could be handsomely rewarded, given Intel’s pretty cheap valuation.

Summing It Up

Intel and Facebook both look like they could be good speculations at current valuations – though if/when Facebook eventually IPO’s, it’s likely the stock will be more fully valued than it is today.  Out of the five tech companies we previewed, these two appear most likely to surprise to the upside, given their current valuations.

Microsoft is toast – don’t go there!  They are a software company that can no longer develop software in the year 2011.  Their existing businesses (enterprise, servers, and even PC operating systems and software) will spin off cash for some time – but beyond that, I”m not optimistic.

And the Big Two in tech – Apple and Google – appear to be valued roughly right.  The future looks good, but everyone knows this.  At least that’s how it looks on the back of my non-digital envelope!


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