MSFT

[Guest VAL9000]

Hey Shalab,

 

I noted that the search % I was using is US-only because I don't have reliable data on the international search share, hence the proxy value.  Do you have better data that we could use?  I tried to find it but couldn't (maybe Bing can find it? hah.)  In addition, I was unable to find an International vs. US revenue split for search ads alone.  The 47/53 split US/international is for top line revenue.

 

It looks like we're in agreement that the search share is worth more to Google than it is to Microsoft.  But what we're still missing is a better estimate of what that 30% is worth to Google.  I used a quick and dirty baseline of $10bn to illustrate a point - that Microsoft does big economic damage to Google by retaining 30% of the market (i.e. that if Google owned that 30% they would bring in additional $10bn.  They don't because Bing does, therefore Microsoft costs Google $10bn/year with Bing).  Now we're debating how big that economic damage is.  I say much more than $10bn, what say you?

 

My rationale on the revenue guess is this:  Search Ad Revenue = Searches * Click Through Rate * Cost per Click.  Holding CTR and CPC steady gives a linear increase or decrease in revenues based on search volume.  I can't think of a reason why increased search volume would decrease CTR, but I can think of a reason why CPC would drop.  More searches increase the supply of ad space, which will reduce the price of the ad space, which will reduce CPC.  I don't actually think that this is the case with Google, but again I'll defer my thoughts for now.

[shalab]

>It looks like we're in agreement that the search share is worth more to Google than it is to Microsoft.  But what we're still missing is a better estimate of what that 30% is worth to Google.  I used a quick and dirty baseline of $10bn to illustrate a point

 

I think it is worth about $4B in revenue at current rates. However, the net profit would be much lower as one has to pay up for third party sites that generate the content.

[Guest VAL9000]

I think it is worth about $4B in revenue at current rates. However, the net profit would be much lower as one has to pay up for third party sites that generate the content.

 

Search Ads aren't a part of the content network; they are exclusively featured on google.com and therefore do not share revenue with content providers.  I bet the net profit would be higher on this remaining 30% based on the assumption that Google's infrastructure today can handle a 50% jump in search traffic.

 

How do you get a figure of $4bn?

 

[Guest VAL9000]

4B is the best case looking forward. I am using your figures. If you split 20B into 50% US, and 50% international, US revenue is 10B. 30% of 10B is actually 3B. No one will have 100% market share, the best case is likely 90%. Then the actual figure is 2B according to current figures.

 

Ok, you are assigning a value of zero for the market share that Bing takes from Google internationally.  I can work with that assumption.  And you're assuming that the split for search ad revenue in the US vs. International is equivalent to the revenue split for top line, which I can also work with.  I can't find the data on this so we'll use what we know.

 

Looking at US only, if $10bn is what Google makes on 65% search share, then the additional 30% would be worth 10bn * 30%/65% = 10bn * 46%  = $4.6bn to Google.  The $3bn you calculated seems to assume that it's a 30% increase when it's actually a 46% increase.

 

So $4.6bn lost revenue on US search share alone.  Plus these additional economic costs:

- competition for search talent - google just raised its salaries in a big way, think that if they were the only game in town they'd have to do this?

- international revenue considerations - ignored by the $4.6bn figure but it's a real consideration.  Even a 5% share on the left-over $10bn makes a difference.

- pressure on technological innovation - Google has to continually invest in R&D to ensure their search results are better than Microsoft's.

- pressure on mind-share - how much does Google spend on advertisements?  They increased their advertising costs by $387mm in 2010.

- deprived of a monopoly - you say best case is 90%, well this is only true if there's competition.  If Microsoft weren't in town, who would keep Google from getting 99% of search?  Yahoo? Please.  If Google had a monopoly on search the profitability would go through the roof.

 

At a loss of $2bn per year, inflicting these costs upon Google seems like a no-brainer for Microsoft.  Even with your $2bn figure, the above factors make the investment worthwhile.

 

[S2S]

"At a loss of $2bn per year, inflicting these costs ($4.6B+) upon Google seems like a no-brainer for Microsoft. "

 

I suppose that is one way to conceptualize things... but I'd also propose that it is probably not the right way to do so.

 

As I tried to point out earlier, you are employing 2 completely different metrics. The $2B figure approximates the run-rate bottom line loss, which more or less directly impacts shareholders' takehome. The latter number, $4.6B, estimates the (a) revenue (b) opportunity.

 

(a) With the exception of perfect AND limitless operating leverage (which is not realistic), incremental revenue never flow through 100% to earnings. And not all revenue streams are created equal - per my example earlier the below-cost gas station business is worth a lot less than your standard Shell station. Yes, Google, should they make it a focus, can absolutely increase their share from from 65% to, say, 80%, but at what cost? Lower margin contracts than their existing book or, god forbid, a price war? Even more regulatory/antitrust pressure?

 

(b) Thankfully, internet advertising is still a growth industry, so share gain from Bing is just one of the multiple opportunities at Google's disposal. Deeper and deeper integration of Google processes into mobile computing, display ads, video ads, China, Japan etc etc, you name it. As long as they can make the pie bigger every year and print 20%+ revenue growth like clockwork, I don't think Page and Brin are losing much sleep over Bing as your posts seem to suggest.

 

You mentioned mind share and compensation costs. Few, if any, of the literatures and discussions I have seen/heard on the topics cite Microsoft as the aggressor. It is either Facebook, which aside from being a black hole of information impenetrable for search engines has also lured hundreds of Googlers with compensation packages that sometimes include 8-figures worth of pre-IPO shares, or the younger players in that booming Internet startup industry.

[Guest VAL9000]

Heheh, you guys are worthy critics!  Had I known that my argument would have faced this much scrutiny, I would have done more DD up front.  So let's break it on down further.

 

a) Revenue vs. Profitability.  Since we've somewhat agreed to the idea that Microsoft takes revenue from Google, what is the profit associated with that revenue?  I'll leave out real-world benefits of being a monopoly (the profit benefits of having no competition) and instead assume that the profit margin from today's search business will continue in a linear fashion.  This isn't the case, it would be more profitable, but I digress.  How much does the Goog spend to run just search?

 

From the top line, expense percentages (~65%) are:

- cost of revenues - 35.5%

- r & d - 12.8%

- sales & marketing - 9.5%

- general & admin - 6.8%

 

My analysis:

- cost of revenues - 26% of 35.5% comes from content payments and therefore don't apply to search or its margins, so i don't count that in the search margin.

- r & d - How much of this is related to maintaining search?  Let's say 60% (8%) is related to search - I'm basing this on 60% of the revenue comes from search, so 60% of the cost is applied.

- sales & marketing - This will mostly continue.  Without bing in the picture they could cut their ad budget, but we'll leave it as is because it's mostly commission related anyway.

- general & admin - Again, how much is related to search?  Again, let's stick with 60% (4%).

 

Total cost of revenue for search based on these assumptions? 31%.  Breaking this out more clearly, this estimate says that Google's costs are 47% associated with search, 40% associated with paying the content network, and 13% for everything else Google does.  This looks like a pretty conservative estimate of where the money goes considering all of the crap that Google is into.

 

69% of $4.6bn is $3.2bn in operating profit attributable to US search only based on a 30% share and all of the assumptions we've made to this point just trying to get the damn baseline number to something bulletproof :)  If you take income tax to that at 35% then you get right at the $2bn mark, but if you take income tax into account then the cost of Bing really goes from $2bn to $1.3bn because of the tax it shields on other (profitable) business lines at Microsoft.

 

b) Tons of opportunity, I agree.  Re: Google's priorities...  65% of Google's revenue come from search, a business that conservatively makes 69% margins.  Do you really think that Sergey and Brin shrug off threats to Google's search hegemony?

 

So now we're looking at $2bn out of Google vs. $1.3bn out of Microsoft based on pretty conservative assumptions, and we still haven't addressed any of the other factors, just the baseline market opportunity.

[Rabbitisrich]

It's difficult to say how much Bing affects Google... using Val9000's analysis as an example, there are a lot of assumptions in terms of spend and opportunity cost. It's worth noting that Google carried ~57% of "core search", as defined by Comscore, in 2007 vs. ~65% in 2011.

 

There is a huge first-mover advantage in "core search". One study tracked the eyeball movements of searchers and found that people pretty much only pay attention to the first lines of the first page. If a search engine provides satisfactory results in those lines, there isn't much room to compete on a result vs. result basis.

 

Baidu offered better speed, local results, and illegal download links but those issues were related to political circumstances rather than a true moat.

[Guest VAL9000]

Hi Rabbit - thanks for your contribution here.  Just a couple of thoughts on your thoughts :)

 

- Google achieved 65% of core search share as of June 2009 - the month before Bing launched.  Search share has been stagnant since Bing's launch.

- Opportunity cost is definitely a factor.  Google's $24bn cash pile made a whopping 1.7% last year, so there's that.

- I believe the spend assumptions I've made are pretty conservative, but where would you say I've gone wrong?

- Google was not the first mover in search in the US and managed to grow its market share to 65% by offering 1) superior results 2) superior experience.  I'm sure there are other reasons but those two big ones can be challenged and are being challenged all the time.  Mostly by Bing.

 

Hitwise tracks this data as well.  I'm not sure if they're biased, but they say Bing's results are superior:

http://www.hitwise.com/us/press-center/press-releases/bing-searches-increase-twenty-one-percent/

 

[Rabbitisrich]

Sorry, when I said first mover, I made an assumption that Google reached a point where incremental improvements in search minimally affect market share.

 

If Microsoft's market share growth, as defined by Comscore, has come largely at Yahoo's expense then Google's flat share isn't strong evidence of competitive pressure. I don't think that Pew has updated their estimates of daily search engine users, but in 2008 it was only 49% of users. If the daily internet usage penetration has improved, and we know that internet user penetration has increased from '08, then a flat market share may simply reflect a mature division of usage. How would one tell the difference?

 

In any case, until Bing starts to shrink Google, it's simply a guessing game.

[Guest VAL9000]

We're definitely in the guessing business :)

 

Over the past two years, Internet search queries have grown about 36%.  Internet penetration in the US grew about 6%.  During that period of growth Google maintained 65%.  These are new users and new searches and Google is failing to capture more than 65% of them.  That's after growing search share steadily since inception.  This is significant.

 

Yahoo has been bleeding search share.  Bing has been gaining search share.  Everyone seems to look at this and think that Yahoo searches are fleeing to Bing.  This doesn't make any sense to me.  We've established that search results and experience are what wins users.  Bing's results are precisely Yahoo's.  As far as experience, their search pages are almost identical in functionality and performance .  And finally other than a "Powered by Bing" footer, there is no reference to Bing anywhere in the Yahoo result set.  Are we to believe that Yahoo's users are simply choosing to abandon their habits and switch to Bing because they like the name better?  That's not what's going on.  This is all out war for those users and for market share.

 

Anyway, that's what I'm going with.  I'm exhausted after being on the defensive for 2 days straight, so I'm closing my end of the argument with this:

 

- The Google revenue opportunity for the last 30% of search in the US exceeds $5bn.

- The profit opportunity for Google exceeds $3.2 bn pretax ($2bn post)

- Microsoft's competitive pressure with Bing forces Google to invest more in search tech and advertising than if there were no competition.

- Microsoft competes with Google for search-experienced engineers, which drives up their average salary, which costs Google (and MSFT). Regardless of what you read in the headlines, this is how the market for employment works.

- Forcing Google to focus on maintaining its search lead means their best engineers aren't focused on other areas (such as Google Apps, which could be a legitimate threat to Microsoft's Office business).

- As a kicker, Bing may prove to be good at search and compete on search-based advertising.

 

These factors, plus many others, are what lead me to conclude that Microsoft's $2bn pre-tax spend ($1.3bn post) is entirely rational and well worth the money.

 

Why do I care so much?  I am genuinely evaluating a serious buy of MSFT.  In doing so, I need to understand Microsoft's strategy as fully as possible.  This weekend's debate has galvanized my zeal for this company.  Or as Ballmer would put it "I. LOVE. THIS. COMPANY.  YEAH!"  reference: http://www.youtube.com/watch?v=wvsboPUjrGc

 

 

 

 

[Liberty]

I'm not sure if it has been mentioned, but quality of searches probably matters. If a large fraction of Bing's traffic comes from people making typos in IE's address bar or stuff like that, these searches are probably less valuable than searches from people going to the site (google.com or bing.com) and actively looking for something.

 

I feel like Bing probably has more low quality search, proportionally, than Google. Unfortunately, that's just a guess, I don't have hard data on this (and I'm not sure if any exists that is publicly accessible).

[ERICOPOLY]

Instead of wasting time with capital destroying actions like buybacks and earnings growth, MSFT should pay out 100% FCF immediately.

 

Like a lot of these global US large caps, they'd likely get hit with more tax if they paid out 100% of FCF.  I hope the tax code gets cleaned up soon so that this sort of thing can be more likely.

 

Right now MSFT is yielding over 5% counting the buybacks.  Most of the rest is likely earned abroad.

[twacowfca]

Hi Rabbit - thanks for your contribution here.  Just a couple of thoughts on your thoughts :)

 

- Google achieved 65% of core search share as of June 2009 - the month before Bing launched.  Search share has been stagnant since Bing's launch.

- Opportunity cost is definitely a factor.  Google's $24bn cash pile made a whopping 1.7% last year, so there's that.

- I believe the spend assumptions I've made are pretty conservative, but where would you say I've gone wrong?

- Google was not the first mover in search in the US and managed to grow its market share to 65% by offering 1) superior results 2) superior experience.  I'm sure there are other reasons but those two big ones can be challenged and are being challenged all the time.  Mostly by Bing.

 

Hitwise tracks this data as well.  I'm not sure if they're biased, but they say Bing's results are superior:

http://www.hitwise.com/us/press-center/press-releases/bing-searches-increase-twenty-one-percent/

 

 

 

FWIW I use google more than bing probably out of habit and because it's the default.  But I intentionally go to bing or wolfram alpha when I search a serious topic such as science, math or any topic where I don't want to see low quality info.  I get ticked off at all the social garbage that often comes up on google when searching a non frivolous topic.  This ticks me off so much that I've given up taking a first stab at the topic through google even though it's still the default.  

 

Bottom line: bing is definitely getting increasing use from at least this high quality, deep pockets potential responder to advertising. :)

[Valuebo]

Bing is one opportunity. What about cloud computing?

Do they stand any chance here? 36 000 engineers working on cloud computing (more than $5 billion R&D expenses for cloud computing are being spen) should bring out some new opportunities in the future. Who are their major competitors in this area for the future?

[ericd1]

From the WSJ

 

"Microsoft is close to a deal to buy Internet phone company Skype Technologies for more than $7 billion, and a deal could be announced as early as Tuesday.

Negotiations were wrapping up Monday evening, and a deal could still fall apart. Representatives for Microsoft and Skype declined to comment.

A deal would represent Microsoft's most aggressive move yet to play in the increasingly-converged worlds of communication, information and entertainment."

 

Not sure I see the wisdom in this move...

 

[Myth465]

I like Skype. Not sure what MSFT would do with it. EBAY lost alot of money on it......

I think in my analysis I may have to discount cash on the balance sheet for these tech companies.

[Investmentacct]

There might be some value in 650 million user base and around 50 million active users a day

http://en.wikipedia.org/wiki/Skype

[given2invest]

what an awful acquisition

 

 

[given2invest]

I like Skype. Not sure what MSFT would do with it. EBAY lost alot of money on it......

I think in my analysis I may have to discount cash on the balance sheet for these tech companies.

 

That would also mean you would need an additional discount to future cash flow that won't be dividend'd out, right?  I mean additional discount on top of the D in DCF.

 

Hence why they trade at 8-12x earnings.  I still think they are all cheap and good investments here - but that's the bear case.

[S2S]

what an awful acquisition

Not for these guys:

The experiment faltered, and EBay gave up on Skype in 2007, taking a $1.4 billion charge on the investment. It sold a 70% stake to a group of technology investors including Silver Lake Partners, venture capital firms Index Ventures and Andreessen Horowitz, and the Canada Pension Plan Investment Board, who will make a handomse return on the Microsoft transaction

 

Read more: http://online.wsj.com/article/SB10001424052748703730804576313932659388852.html#ixzz1LuhJWiCp

 

Seriously though, I agree. Some guys here will argue that doing so blocks a much-speculated Skype + Google/Facebook alliance and the ensuing "opportunity". However, at the end of the day, shelling $7B for something eBay couldn't find a buyer for at $2B just 2 years ago does not scream "value".

[Guest VAL9000]

Interesting development.  It'll take me some time to think through this and as much as I'd love to jump into the numbers right now, I've got some work to do...

 

Some of you seem to have pretty quick judgments on the value here, so enlighten me with your reasoning.

 

g2i - Why is it an awful acquisition?  What doesn't Microsoft see that you see?

S2S - What's the fair price for Skype and why?

Myth - Do you mean that the cash is worth less because tech co's investment track records are weak?  I tend to agree with you here when thinking of CSCO's and GOOG's buys..  but others have been really impressive, such as ORCL and RIM.  MSFT is hit and miss but we discussed this recently.

[turar]

Canada Pension Plan Investment Board

 

Wow, I wonder what else they're up to.

[S2S]

VAL9000,

 

Yes, there's a good chance much of my knee jerk reaction would be proven wrong as we learn more about the deal (which value, btw, DealBook put at $8.5B, so debt assumption is likely involved), but here're a few quick thoughts:

 

- MSN already features a robust voice/video calling platform, hence I'm guessing MSFT is mostly paying for the membership base and talent. Feel free to do the math (which, btw, I rather enjoy in our previous debate) on the former, but it seems like a rich price no matter you cut it. The latter factor is far harder to measure; I imagine though, facing a choice between (a) cashing out after their lockout periods and possibly joining other hot startups and (b) working their way through the massive corporate structure at MSFT, many wouldn't think twice.

 

- Again, the same deal could have been done two years ago for less than 30% of the new sticker. MSFT was just as flushed with cash, and eBay was a (almost too) willing and motivated seller. Why now? Is the economics of consumer* voice/video calling 3 times better than it was back in '09?

 

* I think it's important to make this distinction. MSFT/Skype might pose a threat to commercial players like Polycom or Cisco over the long term, but it'd be another uphill battle facing the Tech giant.

[given2invest]

Simply put, unless they paid less than MSFT's current multiple, I believe this is classic "deworsification".

 

MSFT is classic at expanding into shit they don't have to expand into.  They probably paid a huge multiple for something they didn't need.  Further, the sellers are sharp PE guys.  I'm sure MSFT paid a "full and rich" multiple. 

 

If the article I read is correct, they did $300 Million in operating profit (EBIT) last year so they are paying 30x ebit?  Give me a break.  Ditto what has been said already, EBAY dumped this thing cause it was non-core and not working.  Not sure why MSFT will have any better luck or "synergies" with it.

 

 

[Investmentacct]

Again, the same deal could have been done two years ago for less than 30% of the new sticker. MSFT was just as flushed with cash, and eBay was a (almost too) willing and motivated seller. Why now? Is the economics of consumer* voice/video calling 3 times better than it was back in '09?

 

----not sure about economics, but as a consumer since skype started way back in 05-06 their quality definitely improved much. You can video  conference in people in any timezone in the world and have them on your 55" tv sets, all on hd. We have relatives across europe and Asia. Connecting with them never was easier and good quality before Skype. And, i still remembered paying 5 bucks for 10 minutes every time,  just good 10 years back. And now through skype we connect all over places almost free using hd video calls.

I would think it will end some point of time.

 

I imagine some point of time video call would worth/cost more than just plain audio if it could be chargable. I would pay money for using skype than using AT&T Anytime.

 

Recent iPhone/iPad/tablet skype calls are wonderful as well.

 

One observation was, Skype has almost as many users as Facebook.