Google (NASDAQ:GOOG) is saving�large organizations millions by persuading them to swap Microsoft (NASDAQ:MSFT) Office applications for Google’s so-called cloud-based software as a service. Should this alone entice you to add Google to your portfolio?
At least one 25,000-person organization, InterContinental Hotels, has taken its employees off Microsoft email and Office applications and moved them on to Google’s Cloud Apps, according to the New York Times. For a typical business, Google charges $50 a user each year to use its email and office applications that are delivered from Google’s computing systems. InterContinental estimates that Google Cloud Apps will save it millions.
And InterContinental is not the only one to stick a knife in the heart of Microsoft’s $20-billion-a-year, 60%-operating-margin, Office business. Others that switched to Google Cloud Apps, according to the Times:
- The National Oceanic and Atmospheric Administration, (25,000 employees)
- State of Wyoming, (10,000); and
- McClatchy Group (8,500).
Microsoft is fighting back by introducing its Office 365 for $72 a year. While the idea of competing with Microsoft Office has been around for a while, Google appears to be the first to gain significant traction — it has improved its offerings considerably since they were first introduced.
Google’s revenue just from the four clients mentioned above could total $3.4 million (assuming they are paying full price),�and almost 100% of Google Cloud App customers renew the service. Most likely, these employees are likely to be drawn into other Google revenue-generators, so the relatively tiny Cloud App revenue could benefit Google in other ways.
Nevertheless, an investor in Google shares at its current price ($494) must consider the rest of its business — and whether Google has the potential to deliver compelling upside surprises beyond Cloud Apps.
Google�s stock had a great run between its 2004 IPO at $80 and its September 2007 peak of $567 — rising at a compound annual growth rate of 92%. But the stock has since bounced around and is now trading 15% below that peak.
Nevertheless, Google’s financial performance has been spectacular � its revenue is up 36.7% a year over the last five years, and its net income of $8.4 billion�rose at a five-year average annual rate of�42.2%. Meanwhile, Google’s cash balance beginning in 2006 grew at an annual rate of 33% to $35 billion at the end of 2010, while holding barely any debt.
Google’s most recent quarterly performance was worse than expected due to its massive hiring campaign. In the first quarter of 2011, Google’s net income of�$2.3 billion was up 18% from the year before, but its adjusted earnings of $8.08 share was 3 cents below analysts surveyed by FactSet.
While Google revenue rose 27% to about $8.6 billion, which was 37% better than analysts expected,�Google’s expenses grew faster than revenue — with Google adding 1,916 employees to end March 2011 with more than 26,300 workers.
Is�Google investing too much�in�its human capital�to generate a positive return to its capital providers? No way � it�s earning huge returns on capital. After all, it�s producing positive EVA Momentum, which measures the change in �economic value added� (essentially, profit after deducting capital costs) divided by sales.
In 2010, Google�s EVA momentum�was 3%, based on 2009 revenue of $23.7 billion, and EVA that grew from $3.1 billion in 2009 to $3.9 billion�in 2010.
And�Google’s stock valuation�is reasonable � trading at a price-to-earnings-to-growth (PEG) ratio of 0.94 (where 1.0 is considered fairly valued). Google�s P/E is�18.7 on earnings expected to climb 20% to $35.43 a share in 2012.
While I don’t expect Google Cloud Apps to make a big difference in overall revenue, Google stock is likely to pop if all those new employees can invent services that actually generate new sources of revenue growth.
At its current price, there�could be�more risk�by not investing and missing�Google’s upside over the longer term.
Peter Cohan has no financial interest in the securities mentioned.
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