Before I spent the better part of my Saturday afternoon at the local Best Buy playing with the new iPad, I was convinced I would be walking out with a new toy. Also, after 30 minutes I realized that in its current form the iPad is nothing more than an expensive web-browser.
Its price and limitations not withstanding - Steve Job’s not so subtle claim that the iPad is revolutionary still holds true. Contrary to popular belief this is not a hardware revolution—this is a software revolution. The revolution is rooted in the fact that cloud computing and ubiquitous Wi-Fi have made web based software the future of computing—Steve Job’s knows it, Eric Schmidt knows it and maybe, someday, Steve Ballmer will see it. In the mean time, the fight-and future- is not among the hardware makers (I’m talking to you RIMM), the fight is between Google and Apple .
iPad Kills More than Just Laptops
For years, Google and Apple famously found friendship by thinking up new ways to beat Microsoft at its own game. However, Google’s release of Android based Nexus One and Apple’s purchase of Quattro Wireless pushed the two companies closer to direct competition. Google now has the hardware platform to dominate mobile web advertising while Quattro gives Apple the software to apply its paradigm shifting thinking to mobile ads. The key in this fight is information.
Both companies have access to a treasure trove of data – Google collects virtually every keystroke made during a search, while Apple’s App store and iTunes give it information on buying habits that advertisers covet. Herein lies the rub – in our view, hardware will become commoditized, even the much loved iPhone – but information is always personal. Research in Motion, Palm, Nokia and every other device maker has a fatal flaw in their business plan – they all lack a data base of consumer behavior. As mobile web software develops the device makers will find it more difficult to differentiate their hardware. The iPad is not just a laptop killer - it is a mobile device killer.
Google is Bargain
Much of the focus has been on Google’s withdrawal from China – it has made for great headlines, but China is a small part of the Google story. We view Google and Apple in the same light – they are both software companies with information as their competitive advantage. Viewed in this light we think Google is the more compelling buy.
Google is trading at 18x forward earnings, while Apple trades at a forward P/E multiple of 20. Historically both companies have traded at significantly higher multiples, with Google trading at a PE of 52 as recently as the 4th quarter of 2007.
Using that lofty and potentially unattainable PE would put GOOG at $1600!
Using the more realistic 2008 average PE of 29 puts the target for Google at almost $900 – even a modest multiple expansion to 23 would value GOOG at over $700. One of favorite valuation metrics is earnings yield, or EPS divided by price – using this metric Google’s forward earnings yield is a respectable 5.5% vs. Apple’s forward earnings yield of 4.95%. Moreover, the cash on Google’s balance sheet should please even the most ardent value investors.
Going into earnings we believe the markets will begin to understand that the Google story is changing and the company is a relative bargain despite its 3 figure price tag.
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Kanundrum Capital is long GOOG