Google Shows Restraint, Fails to Outbid Microsoft for Facebook Ad Deal

With a flurry of deals in recent months, Google (GOOG) has seemed willing to pay handsomely for attractive companies and contracts. The online ad leader has received mixed reviews for acquisitions of Doubleclick, Feedburner, and YouTube, as well as their exclusive ad deal with MySpace. With news that Facebook was negotiating with both Google and Microsoft (MSFT) on an international ad deal and a minority investment, it would not have been surprising, given their cash hoard and past deal history, to see Google outbid Gates & Company for the deal, even though Microsoft currently runs ads on Facebook’s domestic site.

In a shift for Google, reports are hitting the wires that Facebook has secured a $240 million investment from Microsoft, in exchange for an expanded ad deal that covers Facebook’s foray into the international market. MSFT is getting a 1.6% stake, which values Facebook at a whopping $15 billion. All this for a company that supposedly is on track for 2007 revenue and profits of $150 million and $30 million, respectively. That’s right, Microsoft is paying 100 times 2007 sales and 500 times 2007 earnings!

There is no doubt that adding Facebook to its arsenal of web advertising properties would have been a boon for Google, but given that Microsoft already has a relationship with them, it is not too shocking that they would expand their existing deal. While prices of less than $2 billion for YouTube and $100 million for Feedburner will likely turn out to be bargains, it was likely tougher to justify a $15 billion valuation for Facebook. Many Google shareholders are probably happy to see the company show some sort of financial restraint, even though Facebook is clearly a hot property in the social networking space.

As for Google stock, the shares have soared to $675 on the heels of another strong quarterly earnings report from the company. I still believe the stock will continue its rise, but future gains will likely be far more limited. I will likely want to sell stock when the forward P/E approaches 35 times, which right now would equate to about $718 per share.

For the bears who continue to point to the fact that Google’s market cap has irrationally matched or exceeded that of blue chip companies like Citigroup (C) and Wal-Mart (WMT), I would caution people against such comparisons. Lining up a software company side by side with a retailer or a bank really is comparing apples to oranges. Instead, I would suggest you compare Google’s valuation with other software companies.

With a low 30’s forward P/E ratio, given Google earnings growth projections over the next 3 to 5 years, I think investors will conclude that Google’s share price is not only quite reasonable, but will continue to rise if the company can deliver earnings growth rates in the 20 to 30 percent range annually for the next several years. Even if you factor in decelerating profit growth as well as continued P/E contraction, you can still project a stock price meaningfully higher than current levels over the longer term.

Full Disclosure: Long shares of Google at the time of writing

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5 Thoughts on “Google Shows Restraint, Fails to Outbid Microsoft for Facebook Ad Deal

  1. Anonymous on October 25, 2007 at 7:47 AM said:

    Let’s see, as of 10:45 this morning MSFT’s market cap is up 5.6 Billion and GOOG market cap is down 1.8B. I wish one of my holdings had bought a stake in facebook.

    GOOG is a “story stock” and the story would have been better with facebook.

  2. Chad Brand on October 25, 2007 at 7:54 AM said:

    I certainly would not disagree that adding Facebook would be an incremental positive for the Google story. I think the newsworthiness of the story from GOOG’s position is that they decided against overpaying for the deal. Time will tell whether or not Microsoft got a good deal or not, but it does appear that Google is showing more restraint, which is notable in my view.

  3. Anonymous on October 25, 2007 at 2:50 PM said:

    Google has simply played Microsoft for Facebook; given Facebook’s existing and working relation with Seatlle it was easy to see which way they’d lean…but they played the sitution and Google played it even better, knowing from the start they won’t win…so they only could make Microsoft lose more 🙂

    Just my 2c.

  4. Sergei on October 25, 2007 at 4:23 PM said:

    Microsoft is doing everything it can to regain online ad revenue from Google. Which do you think will generate more revenue, Facebook or AOL? Microsoft got a sweet deal here and put Google on the defensive, a place they are probably not used to. Good call on the part of Microsoft’s Directors

  5. Microsoft’s ponying up a $15 billion valuation for Facebook is absolutely ridiculous. I’m sorry. But, the company has yet to prove that it can monetize effectively. It’s been 4 years and I know Facebook has been concentrating on improving its platform and offerings and I don’t disagree that Facebook has put out some very high quality web platforms ranging from their development API to just the features that are now included within the network. But, it only has $150-$200 million in revenue mostly from a lucrative Microsoft ad deal and some of the worst click-thru rates online. All this despite the fact that they bill themselves as being uniquely able to access the oft sought after 18-35 demographic. Microsoft basically took a big investment in a company that it is already financially supporting. I don’t like the deal and I’m glad Google didn’t play.

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