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Tweedy, Browne Comments on Google
Posted by: Holly LaFon (IP Logged)
Date: November 29, 2012 04:49PM
As we have mentioned in past letters, value investors such as ourselves often have a difficult time investing in high technology companies largely due to their frequent high valuations, rapid rates of change in technology, and the potential for obsolescence. The last thing in the world we want to do is pay a high price for a rapidly growing business that gets leapfrogged by technological change shortly after we buy it. With this in mind, you might be surprised to know that we began building a position in Google (GOOG) back in February of this year when the stock dipped down to around $565 per share. At this price, we felt we were getting a bargain, paying roughly 12.5 x 2012 estimated earnings net of the cash on its balance sheet. And this was for a business that grows its top line at greater than 20% per year.
Google principally provides paid search, which is an effective, measurable, and high return on investment form of advertising. Google provides paid search on desktop computers, tablets, and mobile phones and has market shares that range from 65% to 85% throughout much of the world. Additionally, Google has one of the largest Display advertising networks in the industry, which is growing extremely fast and is quickly becoming a more meaningful part of the business.
Paid search is more mature today than it was in 2005 and we think that future growth will slow. Nevertheless, Google grew revenue roughly 24% in the first half of 2012 on a currency exchange rate neutral basis and our research suggests that paid search is still relatively underpenetrated. Advertising dollars have not yet caught up with the ongoing shift to ecommerce and digital media consumption, which will continue to drive dollars to paid search as well as Google's fast growing global display network. Display has the potential to be a large business as it is driven in large part by brand based ad spending which accounts for the vast majority of global ad spending.
With market shares in the search business that range from 65% to 85% in most countries throughout the world, it is reasonable to conclude that Google has a strong competitive position. Google's revenue is roughly 15 times higher than its nearest competitor, which has enabled them to put significantly more money into R&D, distribution, and the development of products and eco-systems that further promote and protect the use of Google's search. Moreover, as Microsoft's investment in search can attest, the search business is expensive to enter. However, like every investment we make, Google is not without risks. Vertical search, uncertainty regarding future growth rates, and risks related to Apple's strong share in smartphones and tablets all need to be monitored closely. Nevertheless, we feel that Google is well positioned to protect its interests and, perhaps most importantly, we paid a price that we felt more than discounted these potential risks.
We bought Google at roughly 12.5 x 2012 estimated earnings net of the cash on the balance sheet. We think this is a very low valuation as companies with market leading positions secured by strong competitive advantages in secular growth markets typically do not trade at market multiples. Unlike most companies growing revenue over 20% per annum, Google is also able to generate significant free cash flow due to the phenomenal economics of paid search. For these reasons we believe Google is undervalued and deserves a significantly above average multiple.
From Tweedy Browne's Investment Advisor's Letter and Semi-Annual Report.
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