Google has now given back $150+ per share and about $50 billion of market cap. How low can the stock go?
First, a recap of what investors are worried about:
- Revenue deceleration. Google’s revenue unit growth (paid clicks) decelerated sharply in Q4.
- Recession. The market is concluding that search won’t be “immune” from economic weakness.
- Wireless. Will Google dump $5 billion into spectrum and another $5 billion into infrastructure? No one knows–and the uncertainty is freaking people out.
Even a deep recession would only likely have a temporary impact on the stock: At some point, advertising would recover, and the stock would, too. Revenue deceleration and/or a radical change in the company’s business model, meanwhile, would likely lead to permanent multiple compression.
We think it is unlikely that Google will decide to become a phone company, but it might blow a year’s worth of cash flow on spectrum licenses. Revenue unit deceleration, meanwhile, almost always leads to multiple compression–as the momentum investors who have happily tagged along for Google’s rocket ride bail out.
How low could the stock go? At a peak of around $750, Google was trading at about 50X 2008 estimated free cash flow of $5 billion. This wasn’t crazy, but for a company this large, it was also a momentum multiple. Now that revenue is decelerating sharply, we think Google’s cash flow multiple will gradually compress to a more typical 20X-30X. (eBay, another stock that used to trade at 40X-50X, is now down at 15X, so don’t fool yourself into thinking that 20X-30X is an absurd fire-sale price).
Where would that leave the stock? 20X-25X $5 billion of cash flow puts you at a market cap of $100-$125 billion, or about $300-$450 a share. Right now, with the stock at $495, the free cash flow multiple is about 30X-35X. This is far from outrageous and might be sustainable, but it also assumes that Google’s revenue growth will soon stabilise in the 20%-30% range and that free cash flow will continue to grow rapidly.
PS: TechCrunch asked how we feel about our 10-15 year Google $2000 scenario. Very good, actually. In the months since we published that post, Google’s run-rate free cash flow has jumped to $5 billion. Perhaps if the stock gets truly smashed, we’ll get a chance to put our money where our mouth is.
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