Apple or Google: The Race to $600 per Share

Written by on July 9, 2011 in Investing with 10 Comments

I know.  I know.  I know.  Apple reaching $600 before Google sounds absurd. Google which closed at $532.25 / share on Friday only needs to appreciate 12.7% to hit $600, while Apple at 360.25 /share would need to increase 66.5%.  As crazy as it sounds, if Apple outperforms Google at the same rate as last year it is doable.   In 2010, Apple outperformed Google by 57.3%.  Duplicating that performance, starting now, gets Apple there first.  So, based on past performance it’s possible.  However, that’s not why I am writing this article.  Two reports released Friday morning – got me thinking about this.

First, Morgan Stanley downgraded Google from $645 to $600.  The report was brutal.

  • Debate #1: Will margins decline from here? Yes.
  • Debate #2: Will “newer” businesses drive near-term revenue outperformance? No.
  • Debate #3: Will investments in local eCommerce and / or social pay-off? Too early to tell.

As a Result, We Are Reducing Our Estimates:

We are reducing our profitability estimates (now significantly lower than consensus) due to the following: 1) Google’s aggressive hiring plans, 2) rising salaries due to a competitive hiring environment, and 3) increased advertising spend to drive usage of new / existing products.

In 2011, Morgan Stanley expects search & contextual ads to contribute ~90% of Google’s net revenue.  Thus all other businesses such as DoubleClick, YouTube, AdMob, Android Market, and mobile search will only contribute 10% of revenue.  It is simply not a good business practice for a company to be so reliant on one revenue source. Interestingly this is by design and may become their achilles heel.

Google is an advertising company “fronting” as technology company. Its reason for existence is to get as much advertising in front of as many people as possible. This changes the traditional technology game from providing the “best product at the best price possible” to providing the “cheapest ‘good enough’ product possible.”

No one that has used Excel extensively will tell you that Google Docs is better.  However, 90% of the time Google Docs is good enough – especially since it’s free.  That simply kills the price that Microsoft can charge for Excel.  Most people will say – who cares it’s time for Microsoft to get its comeuppance. Yea, but what about the start up that had a more innovative spreadsheet program that couldn’t compete with free?

Google employs this strategy down its entire product line – that’s why the other products only bring in 10% of its revenue.  However, they can only play this game as long as the cash cow (desktop search advertising) is providing milk.  As the market trends away from desktop computing to mobile, the Street is becoming less convinced that Google can commoditize the mobile market and stuff it with ads before the cash cow runs dry. At least that’s part of the reason for the Morgan Stanley downgrade.

The second report that I read was speculation that Apple had just inked an iPhone deal with China Mobile. China Mobile is the world’s largest wireless carrier with over 611M subscribers.  Brian White, Ticonderoga Securities’ chief Apple analyst, has a boilerplate sentence stored on his computer that goes like this:

We believe the ramp of the mobile Internet in China will be one of the great wonders of the tech world over the next decade and the country has clearly caught “Apple fever” that we believe will only accelerate as the company expands it carrier base to include both China Mobile and China Telecom.

If the deal is struck, Ticonderoga Securities thinks Apple’s stock could skyrocket north of $600.

There you have it. Two different Wall Street analysts with $600 targets on both companies. As well as, the math based on last year’s performance showing that it’s possible for Apple to get there first.  Of course, you still don’t believe it – but that’s what makes a market.

 

Disclosure:  Long Apple and Short Google.  Positions may changed at any time.

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  • http://profiles.google.com/joshpritchard Joshua Pritchard

    Your article seems to be taking the MS report as fact — but there have been (at least) four other firms to either raise or reiterate their buy ratings and targets over the last two weeks with theses that directly contradict those of the MS analyst. Scott Devitt is a contrarian with an interesting recent history with Google. Just 7 months ago he raised his target on GOOG to $730, primarily on the basis of Google rolling out Google Instant … which was interesting, because the company has repeatedly said that Google Instant was intended to be a revenue-neutral product enhancement (and it has been).

    Devitt’s report aside, I think Google will be over $600 by the end of this year, and likely much sooner that that. The Panda update hit AdSense net revenue by about $200M last quarter, but no one seemed to really notice because the unexpected increase in display revenue more than offset the drop in AdSense rev, resulting in a $200M beat on top line (remember, the “miss” was only on the EPS side). The company has since said that the adverse effects of Panda on AdSense were largely transitory, which makes sense to me. My expectation is that the display revenue has continued to grow above estimates, while the AdSense revenue has likely returned closer to the pre-update levels. If both of these are true, I believe that Google could be set to beat the consensus revenue estimate by $300-600M. I’m less confident they will beat on EPS, though, since I believe spending on hiring and advertising has actually slightly increased since last quarter. If they miss on EPS, I think it’ll take a quarter for 600 to come but otherwise my bet would be that it happens within a month after the July call.

    All this said, I have roughly equal long positions in both Apple and Google and would LOVE to see Apple fly to 600 :-)

  • http://michaelkdawson.com/ TrendRida

    Thanks for the comment. The beauty is that both are reporting over the next two weeks and the MKT will have plenty of data to digest & react to. 

  • Paula at AffordAnything.org

    My partner and I both owned Google stock, and not knowing whether to buy or hold, we hedged our bets: he sold his holdings last November when the stock was at $600 ($603, to be exact), while I’m holding mine for the very long-run.

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  • http://twitter.com/TradeNerd Kurt

    Trend-
    Though your view on Google differs from mine, I always enjoy having my investment thesis challenged. I have a few questions for you:

    1) What do you believe is a fair valuation of Google and/or a medium term price target?
    2) Are you planning to hold your short into earnings next week? 
    Disclosure: Long GOOG / Short Put Spread

    Regards,
    Kurt
    TradeNerd.com

  • http://michaelkdawson.com/ TrendRida

    1) As far as a mid-term price target, I think a lot depends on the earnings call.  If Larry Page lays another egg like in the last call – it will continue its descent that was broken with the Google+ announcement.  However, you gotta think that he won’t repeat that mistake.

    2) I haven’t decided if I am going to hold thru earnings yet. The smart move would be to close it before the call and re-evaluate after the call. I still have a couple of days to convince myself to do the smart thing :)

  • cayman

    The Iphone in  China, great but isn’t it expensive to be a  MAJOR seller there without being under cut by the asian rivals ??

  • http://pulse.yahoo.com/_4OP2R4LMFNTGL6IB3KGGVKXODU keith evans

    Yes it does sound absurd!

  • http://michaelkdawson.com/ TrendRida

    I expected a few comments like this today.  Not the first call that I missed – won’t be the last one….

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