Google's Worth $900

 | Dec 19, 2012 | 5:32 PM EST  | Comments
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Google (GOOG) has become a tech company focused on a number of things: social, Android, ads, YouTube, Chrome, and research. The company will have some megahits in the years ahead and shares are worth more than $900 each, revealing substantial upside from current levels.

Giving away one's mobile operating system certainly isn't as profitable as selling one (at least in the short term), but Google is betting that stealing market share will inevitably lead to dominance, which it will be able to exploit later. That strategy has made the Android OS the most used mobile operating system in the world, with Apple (AAPL) second and Blackberry a distant third. But the open source code of the Android OS may lead to lower retention rates.

Lower retention rates for its system may not be totally Google's fault. The problem may actually lie with the hardware manufacturers. HTC, Samsung, LG and Motorola all use the Android OS, but the experience differs across producers. Further, the actual quality of the hardware is inconsistent and users don't have the option of going to an "Android store" for repairs and refunds. We've seen a shift in the Android market to consumers primarily purchasing the luxury phones like the Galaxy SIII and the Note.

In earlier research, we noted that we expect retention rates for Android to be lower than iOS (Apple's operating system). We think iOS will likely become the leader in market share in the U.S. But since most carriers do not subsidize phones like carriers in the U.S., it looks like Android will dominate global market share due to lower average selling prices on smartphones. Rumors have surfaced that Apple may try to build a cheap phone to compete, but we think they'd rather lose market share than put downward pressure on margins.

Furthermore, Android has yet to penetrate the tablet market. While Research in Motion (RIMM) and Microsoft (MSFT) have yet to pose a competitive threat, we don't see Android tablets gaining the market share or stickiness of the iPad.

Google+

With more than 100 million members, one would think Google+ is a thriving social network. But that doesn't seem to be the case. The April 9 issue of Bloomberg Businessweek revealed that users spend an average of 2.5 minutes per month on Google+ vs. 7.5 hours per month on Facebook (FB).

Admittedly, Google+ has several cool features unavailable on other social networks like hangouts, where you can Web chat with a group of friends, and circles, which allow you to decide who you share your posts with. But features don't create a social network, networks do.

Unlike Facebook or Twitter, where one must consciously go through the sign-up process, Google+ takes two minutes for users with Gmail accounts. So, we think the actual new user base is significantly smaller.

Search

Although we aren't particularly bullish on Android or Google+, let's not forget about Google's search/ad business. Though Bing seems to be gaining market share, which Forbes estimates was at 15.1% at the end of 2011, Google still dominates, with 66% of the search market. Adsense still generates the vast majority of Google's high-margin revenue.

Much like social, we think Facebook and Twitter are bigger threats to search than Bing or Yahoo! Facebook and Twitter are getting so good at dominating users' time spent on the Web that companies now post their Twitter handles or Facebook pages on commercials and in stores, rather than their own websites.

The big risk for Google is that Internet users bypass Google and go directly to Facebook and Twitter to search for what they want. Search functionality might be mediocre on Facebook, but remember that Microsoft owns nearly 2% of Facebook and could lend some of its search technologies to improve the user experience.

It also appears that mobile ads are stealing market share from desktop ads, but mobile ads seem to lack the same ROI and aren't nearly as effective as desktop ads. Facebook reported fantastic increases in mobile ad sales and we see Instagram as another potential mobile revenue driver. Google will have to focus on innovating in the mobile market in order to stay relevant to advertisers looking to reach consumers via smartphones and tablets.

But it's important to remember that Google does -- and will likely continue to -- dominate the rest of the Web. Adsense is still among the top advertisement products in terms of ROI and its share is dominant. This will continue to fuel Google's profitability.

Research and Development

If there's one area that could propel Google far above our fair value estimate, we think it lies in research and development. With an army of engineers and brilliant computer scientists, some amazingly innovative products could come out of research and development at Google.

Project Glass was released in early April, and while it may not be for everyone, it's certainly exciting. Glasses that allow you to control social networks, search and take pictures all-in-one seems more like a sci-fi fantasy rather than a possible reality. But Google is working on it.

In Google's home state of California, the company recently won government approval for testing cars that drive themselves. Google Fiber is another project that could be a game-changer in the Internet realm. The test city is Kansas City, where the company rolled out its Internet fiber optics network.

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