Why Didn’t We All Just Buy $GOOG?

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In their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discuss Why Didn’t We All Just Buy $GOOG. Here’s an excerpt from the episode:

Tobias: Let’s do the Google. Why didn’t we all just buy Google and go to the beach? I think I’ve heard people buy it now. I haven’t closer look but if you don’t like it.

Jake: We’ll get to that, too. All right. When I look at Google and I say like, “Okay, why haven’t I owned it for the last five or six years?” I’ve been to the campus multiple times, I know lots of smart people that work there. I’m very impressed by the culture more generally, read a couple books about it, recognize that search and the ad cells from search is easily one of the best businesses to ever spawn on planet Earth. It’s incredible. Knowing all of that, how did I miss it and really trying to rub my nose in this mistake? Because this is one of those big opportunity cost loss that really hurt. So, it’s good to unpack it.

In this process, I tried to put myself and transplant myself back to 2015 and then just look at all of the numbers, the financials from say, 2010 to 2015 and just get a sense of what would I have paid in 2015 and if I looked forward another five or six years of what I thought the business might do, what would have been a reasonable expected return and then what actually happened? So, I’m going to walk through the numbers and I might move quick, but I should probably put this together into a tweet storm or something so that the numbers are a little bit more easy to follow along.

So, in Google’s income statement from 2010 to 2015, revenue grew from $24 billion to $66 billion. We have a 22% annual growth on revenue top line for those five years. Operating margin in 2010 was 35%. That went down to 25% in 2015. I don’t know if this is like moonshots or whatever the hell was pinching the operating margin, but margin was trending down. And then you had the 2015 valuation. The EV/EBIT was 19 times. The average EV/EBIT over that 2010 to 2015 period was 17 times. So, it was roughly trading where it typically traded in 2015 if I was to consider buying it. So, you had a market cap of about $360 billion, and EV the cash balance was had started out at $24 billion in 2010 and then gone to $63 billion. So, the cash balance actually was on a 20% CAGR as well. So, backing the cash out, you had an EV of $307 billion in 2015.

So, let’s start from there and then I imagine like, okay, I’m going to make projections to the year 2021 like, what would I have expected this business to do? So, I assumed 15% CAGR, which it was 22% I said previously, but a company that big, if you look at the base rate book that now boasts and put out you would say, “Boy, there has to be something really special going on here to ever imagine that you could keep compounding at that level.” So, I’m just going to back it up. I’m not going to say it’s dying, but I’m going to back it off somewhat. So, 15% CAGR. That would make them revenue growing from $66 billion in 2015 to $152 billion in 2021. All right, I’m going to assume operating margin falls to 20%, which remember, it had gone 35%, 25%, I’m going to assume it found a reasonable level of 20%. So, that would then make earnings grow from $17 billion to $30 billion from 2015 to 2021.

And then I’m going to stick a 20 EV/EBIT multiple on that. Like I said, it was 17 for that average of 2010 to 2015. So, I’m already imagining a pretty good exit multiple at that 2021, I think. So, you end up with an EV of about $600 billion. So, grow that cash balance again by 15% CAGR to then back into a market cap of $455 billion then is what I would have come up with as my projection of the market cap in 2021. So, $360 in 2015 that was known, my projection’s $455 in six years, that’s a 4% CAGR. Okay, that’s not that amazing. I thought I gave them reasonable credit, I gave them a 15% top line growth, I gave them 20 times multiple, 20% margin. These are all pretty healthy assumptions I think like I’m not going crazy. Well, what actually ended up happening?

Revenue grew to $182 billion, which was an 18% CAGR. So, the revenue growth rates slowed down a little bit. I gave them 15%, they came in at 18%. All right, not that far off. Operating margin came in at 23%, I gave them 20%. All right, we’re not that far off there. So, then an EBIT of 42. Here’s where the thing went sideways for me. Multiple went to 31 times EV/EBIT. I was giving them credit for 20. So, I was off by quite a bit. So, that comes in that and at $1.3 trillion for the EV then at that point, back out $137 billion of cash, and you end up with a market cap then of basically like $1.1 trillion in 2021. So, share count basically stayed flat, like they retired, whatever they issued and in stock options to all my friends that work there.

So, you ended up then, the market cap going from $360 and 2015 to $1.1 trillion in those six years, which is a 22% CAGR that I missed. So, my projections, what I thought were reasonable came out with a 4% potential CAGR and it ended up coming in at 22%, and basically, I was a little too pessimistic on top line and I was a little pessimistic on margin, but I was way too pessimistic on what everyone else was willing to pay for it at 20 versus 31.

Tobias: So, is the analysis that you didn’t make a mistake because on the assumption that you made at the time it was the right decision?

Jake: I would say that my–

Tobias: Or sort of false humility aside.

Jake: Yeah. No, my down the middle like base of what I imagined the business would do was probably a little pessimistic even looking at it today. So, it was a little bit more right-taily of an outcome. What you maybe should have expected was such a great business and so many smart people working there and so many ways to win. Now, here is where it gets insane. In the last nine months, so trailing 12 months from the last report which is 930, 2021, revenue has grown to $239 billion, which is a 44% CAGR over the last nine months. Operating margins jumped to 30% from 23%.

Tobias: Whoa.

Jake: Yeah. So, EBIT $72 billion which is 105% CAGR over a year.

Tobias: Whoa.

Jake: So, the multiple actually came down a little bit from 31 to 25 EV/EBIT, but you still end up with a 77% CAGR in the EV over the last nine months. So, this thing just went absolutely phew, I mean, it’s insane.

Tobias: Why did it take off? Is it a lockdown thing or is it, what is it?

Jake: Yeah, I think it’s lockdown, everyone on the internet all day long now, I don’t know. Bill, you probably have a better idea why.

Tobias: YouTube?

Jake: Yeah. Maybe. [crosstalk]

Bill: I think they reined in some spending buybacks started to become a priority, get some more e-commerce, more advertising traveled, advertising starts to come back. I don’t know exactly all the reasons for the inflection up. But I do think like, so, if you just hang a 75% tax rate on a 20% EBIT or 20 times EBIT multiple, like 26 times, I don’t know. I think the ROIC probably requires slightly higher multiples for this business.

Jake: Especially 30 buybacks [crosstalk] instead of moonshots that don’t ever materialize.

Bill: Ah, what?

Jake: Yeah. It’s okay.

Bill: Yeah, yeah, yeah. Well and then they got GCP starts to show some flash and I don’t know. You start to get some religion on what actually matters from spend, and you get a CEO change, that guy gets focused on some things. I bought it when the CEO turned, I increased my position when the CEO was named and actually, I thought it was less of two people’s pet project and closer to a business that was going to be running for public shareholders.

Jake: Good man.

Tobias: A comment here from Dylan Thompson saying, ” Google going to rein in the headcount and expenses like Bezos did to Amazon back in 2018.” I tend to agree with that, I did a deal with them when I was General Counsel of the Telecommunications company in Australia, and we were just astonished at the amount of money that they spent. They are fully first class.

Jake: Oh, yeah.

Bill: As a shareholder, I don’t know that I really want that to be honest.

Tobias: But they have that lever to pull at some point is, it doesn’t have to be now. But if they ever look like they’re going to miss number, say, everybody, you got to fly business class now.

Bill: Yeah. I mean, YouTube is a fucking monster, man. My kids don’t even watch TV anymore. I don’t know. Thinking really long and stuff like IP that’s tied to the bundle. I guess, Viacom bought Ryan, or the rights to Ryan or whatever.

Tobias: Oh, the kid who does the unboxing?

Bill: Yeah, well, he had Ryan’s play house or whatever. But my kids watch stuff like The Fun Squad and just these families that pimp their families out. My kids love that stuff.

Jake: Yeah.

Bill: Bizarre.

Jake: My kids like to watch other people play video games and then yell over the top of them while they’re playing the video games. It is so annoying to listen to that. [laughs]

Bill: The other thing is, Google, they have a lot of stuff that’s working in a big way. I was doing ROKU research and ask some of my international peeps like, “How do you guys watch TV?” The amount of people that are watching on Android stuff, I think as a US focused person is easy to miss. Then, once you think global, Google’s a monster.

Jake: Do you guys want to try walking forward five years from here to see what it might look like? [crosstalk]

Tobias: Yeah. Just before you do, there’s a good comment from Wolfflow. “They took away the dislike button so there’s nothing not to like.” That’s a good one.

Jake: [laughs]

Bill: Well, I see dislike on ours right here.

Tobias: They don’t count them.

Bill: Yeah, that I don’t want– [crosstalk]

Tobias: You mash that button. It’s just you.

Jake: Smash that dislike button.

[laughter]

Bill: It’s a bad idea. I’ll do it and I’ll come back with an actual not off the top my head answer.

Jake: You’ve done some analysis, JT?

Jake: Yeah, of course. We’ll try to walk through the same exercise but from today looking forward, what might it look like? So, let’s assume first of all that trailing 12 months from 931 is close enough to call that 2021 and we’ll just work forward from there. Let’s assume revenue grows at 15% CAGR for the next five years. It was 18% the previous five years, but they just had this monster 44%– [crosstalk]

Tobias: Listen, JT.

Jake: I know. Fuck. [laughs] Someday, there’s going to be some reversion to the mean, where you can’t just grow to the sky. Well, you can just put up 44% last year, you would think that maybe that was put forward a little bit.

Tobias: I’m not criticizing. How often you are going to be too pessimistic on your assessments like not very often?

Jake: All the time, apparently. So, revenue then at 15% CAGR gross from $239 today to $480 in 2026. Let’s give them operating margin at 25%. Like I said, 30% this year, but let’s just say that there is some drift downwards there like, it’s tough to run a business and be that profitable all the time but they continue to do it. So, that gives you earnings growing from $72 billion today to $120 in 2026. Let’s give them a 25x EV/EBIT. They’ve averaged 24.5 over the last five years. We’re paying up at the end of this terminal value, all right? So, that gives you an EV of $3 trillion.

Tobias: Modest.

Jake: Yeah, $3 trillion is a big business. We’re going to assume the cash balance of today grows at a 10% clip, which matches the last five years. So, that’s going from $142 billion to $234 billion. So, we’ll back that out to give us a market cap of $2.7 trillion let’s call it. So, going from today 1.8% to 2.7% in the next five years, that’s an 8.8% CAGR over the next five years if they can deliver those results and that’s what people are willing to pay for it. Well, let’s then also assume another 2% share count reduction if they’re buying back shares, which looks to be what they’re starting to do.

So, even with very optimistic assumptions, I think, maybe I’m wrong again here as always, but 15% revenue growth rate, 25% operating margin 25 times EV/EBIT, you only get about a 10% expected return from here, which I mean, 10% is okay but there’s still some level of execution risk baked into getting to that $3 trillion. I put together a little bit more of a bearish scenario let’s call it. Because maybe, I don’t know I’m wired that way but let’s just assume that they grow 5% revenue growth rate off of a huge base.

Bill: No way.

Jake: Huge base.

Bill: No way.

Jake: [laughs]

Bill: No fucking way.

Tobias: He’s doing a pessimist [crosstalk]

Bill: I don’t care. It’s not realistic in my opinion.

Jake: All right. Well, let’s just humor me for two seconds.

Bill: Okay.

Jake: All right, that gets you to about $300 billion in revenue in 2026. By the way, like–

Bill: Is this real or is this nominal?

Jake: [laughs] Does it matter?

Tobias: That’s nominal, is it?

Bill: Yeah, because I mean, if we’re going to say inflations like– [crosstalk]

Jake: It’s nominal.

Tobias: 5% is inflation .

Jake: All right, fair enough. Call it real. But let me remind you, though, that 2019 revenue was $160 billion. So, we’re 2x-ing revenue from 2019. This isn’t insane.

Bill: There was a big change from 2020 till now.

Jake: I know. Exactly.

Bill: The world did change.

Jake: That is true. All right, let’s shrink operating margins to 20%. They were 22% in 2019. So, this isn’t unprecedented. That actually changes earnings of $72 billion today to $61 billion in 2026. Because they’ve just been like so blow it out for the last year. Let’s give them a 15 times EV/EBIT, which was the average from 2010 to 2014. So, again, not unprecedented. That gives you an EV of $915 billion, okay?

Let’s assume that the cash balance stays at $142 and then, we’re doing pessimistic and we’re going to say that they piss away some of the money, they don’t do buybacks, it’s all moonshots and first-class tickets. So, that gives you then a market cap of $773 billion which that’s a negative 15% CAGR from today to 2026 if that’s what happened. So, I don’t think these are crazy pessimistic assumptions to have 5% revenue growth, 20% operating margin, 15 times EV/EBIT, and you end up with a negative 15% CAGR from here.

Bill: It’s not going to happen.

Jake: Well, I’m not saying this is a likely scenario, but I don’t think it’s a 0% chance, do you?

Bill: I think that plucking 5% out of the year is not– Yeah, I think it’s very, very low probability scenario. Yes, I do.

Jake: You could be right. I’m not saying that you’re wrong there, but you are trying to wrap your mind around the potential things that could happen– [crosstalk]

Bill: I understand. But to the upside, you got Waymo there, like, that’s not nothing. You got GCP there, that’s not nothing. You got a continued structural move to digital advertising, the world going more mobile. Man, 5% is tough for me to buy. I’m not saying it’s impossible, but I don’t think it’s probable which you don’t either. To be fair, you’re saying it’s a bear case.

Jake: Yeah, I would say that you really cannot believe it if you’re going to be long from here.

Bill: I do not.

Jake: That’s fair.

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