Google: So Long, Free Cash Flow

Okay, back to the trees...   

Last year at this time, Google was on track to generate about $2 billion in annualized free cash flow.  This fantastic sum--half the free cash flow generated by the largest media company in the world, Time Warner--combined with the free cash flow growth rate (100%-plus), made the stock's valuation tolerable.  Street projections of free cash flow for this year, 2006, soon soared beyond $3 billion, and it seemed only a matter of time before Google's cash flow exceeded Time Warner's (as it someday must, if the company is ever to justify a valuation far in excess of Time Warner's, which it already has).

But then the company began to ramp CAPEX at the same time that new accounting rules forced it to reclassify some of its operating cash flow to financing flow (tax savings from stock-option exercises).  And then it started buying buildings, data centers, etc.  And then free cash flow stopped growing...and then started declining.  Precipitously.

The net result of all this is that the company generated a paltry $142 million in free cash flow in Q2 and, so far this year, has generated about $600 million.  Back out the $319 million the company just spent on its Googleplex, and you get about $900 million in "normalized" free cash flow for the year.  Double that for Q3 and Q4, and you're about where you were at this point last year--on track to do about $2 billion in FCF, a far cry from the $3 billion-plus the Street expected earlier this year and zero year-over-year growth despite a near doubling of revenue.

What does this mean?  Hard to say for sure.  A significant chunk of the current CAPEX appears to be one-time in nature, so the company will probably be able to cut the spending at some point in the next year or two.  Even so, the Google business model seems to require more capital than it appeared to a year ago, a condition that will likely require a permanent recalibration of analysts' free cash flow expectations, as well as a reduced ROI.  All else being equal, this should translate into multiple compression (especially P/E multiple compression), and it is probably one of the reasons the stock is well off its high.

Comments

[anon]

First here

[Stockpro52]

If I heard correctly, Schmidt said on the conference call that capex would be "accelerating", and that the only limiting factor is "electricity".

Also, isn't the tepid A/H performance reflective of the market no longer looking backwards, which is what 2Q shows us, and now anticipating a consumer slowdown and thus a deceleration of clicks and rev's going forward? This, combined with accelerating capex, could result in FCF compression as well as multiple compression, I'd surmise.

[Victor]

Henry, congratulations on your estimates. I think i was the closest of your readers, but you did an excellent job this time. Great stuff

[Victor]

btw I was closest on top-line two quarters in a row!

[CashForFlow]

High P/E stocks, like GOOG, are getting hammered. People fear the Fed will send us into a recession.

Also, $2 Billion in FCF is reasonable given the large capex in the beginning every company's life. I don't know when the capex will level-off, but the growth in GAAP EPS is worth a considerable premium.

[billy]

KT,
are you telling this story just to hide the fact that your were seventh??

[bellerose]

Henry -

Did you notice the 22% from interest income!?! that is rather significant contribution to there earnings.

[Henry Blodget]

Sorry to ding the post, KT, but I don't want the blog to get a Triple-X rating.

[KING TROLL]

Billy was on the money. I slipped up and was 7th. Man that was terrible. On the bright side I did click on a few ads!

[billy]

i dont think ive used google or any search engine in like 3 weeks.
its all spam websites populated with AdSense.
just an opinion from an upset shorter of the stock.

[Aaron]

I can only agree with King Troll. The perceived value to me of Google's search service is lower each time I use it, because exactly what King Troll indicates. I think Google has passed the threshold of serving its comercial self-interest at the expense of giving the user an honest entry into the internet.
Unless it is impossible for an incumbent to provide exactly that entry - which would be for some technical reason I am not qualified to judge - Google will remain as dominant as it is, but only then!
Does anybody with a mind capable if thinking, as opposed to following, consider Google cool anymore?

[goog]

Hi, Henry: I think you are looking at the leaf.

Operational cash flow was 840 vs 820 million Q/Q.

[billy]

i remember back in the 1920s when the phone book had a 7 billion dollar market cap which was huge back then and all the phone makers had 1 billion market caps. it all changed eventually...

[Victor]

http://yahoo.reuters.com/news/articlehybrid.aspx?storyID=urn:newsml:reuters.com:20060721:MTFH13627_2006-07-21_22-23-41_N21249525&type=comktNews&rpc=44

Expert report backs google's approach to click fraud

[Victor]

hey henry when are you going to do the sweep stakes summary?

[john]

Google Checkout is offering $10 off $20 or more spending at Starbucks and other stores. I think Google may be getting desperate in getting more people sign up for checkout. Also the list of checkout partner is growing but very slowly. The success and failure of checkout will have a major impact at next earning report and stock price.

[expertwitness]

Uh, yeah, i'm SHOCKED, I tell you, SHOCKED, that the expert witness who was hired by the lawyer who is getting paid 30 million dollars DIDN'T SAY ANYTHING THAT WOULD DERAIL THE SETTLEMENT.

Google and the lawyer had to agree on the guy, which is a joke since the lawyer and google both want one thing- a SETTLEMENT. The settlement doesnt give a penny of money to ANYONE except the lawyer, and it makes google immune to billions of dollars of previous clickfraud claims.

Of COURSE they both agreed on someone who would say "there's no clickfraud problem"

the best part is that this assclown expert witness concluded that while Google refused to give him any actual evidence or logs or anything concrete whatsoever to make his decision on, he was allowed to visit the campus and hang out with some engineers on three seperate occasions.

And those engineers told him that clickfraud is under control. Expert witness response? "That's good enough for me!"

If the judge doesn't totally throw this guys findings out the window, it's pretty clear the judge has been paid off.

Which isn't an unlikely thing- since this Arkansas judge has presided over about 70 class action claim lawsuits in his career, and always agreed on a settlement, half the time with that lawyer Stephen Malouf. It's a fucking racket. Oh, btw, when Malouf isn't busy collecting 30 million dollars from Google, his practice's other main area of focus is defending african warlords, particularly in zaire, from charges of corruption, genocide, and mineral rights theft.

In other words, when it comes to slimy lawers, Stephen Malouf is at the top of the list. This settlement was a criminal sham from the very beginning and everyone involved with it knows it.

[sufiy]

Henry Blodget in his analyses is right: the only way to understand real financial picture in all this creative accounting is FCF Free Cash Flow which is determined as Operating cash Flow minus Capex: capital investments into business. http://www.internetoutsider.com/google/index.html if we will follow his logic and give GOOG generous estimation of 2 billion FCF its multiple MC/FCF is 120.9/2=60.45 with single digit growth of 9% in revenue Q2 over Q1 http://www.awadallah.com/blog/ such valuation is completely unsustainable. Plus all usual suspects to consider: click fraud (no single word on GOOG CC http://internet.seekingalpha.com/article/13986, YHOO started CC with its very important issue http://internet.seekingalpha.com/article/13811), SBC stock based compensation is not expensed fully 375-109 (Q1)-115(Q2)=151 million to eat from earnings into the second half, " ...growth rate in capex in 2006 will be substantially greater than the revenue growth rate for the year.", declining Operating margin to 38% (YHOO is 41%)

What is reasonable multiple: YHOO at the moment has 36.47/1.4=26! (1.4 billion in FCF is middle of the range confirmed in guidance on CC) and it is multi revenue stream business with stable subscription base of loyal customers.

For GOOG to reach "reasonable" valuation of 30 with MC 2*30=60 billion in the economy going into recession when advertising will be cut first stock price will have to fall to 60000/310=193.5

I will be generous: at 200 I will not short this stock.

http://sufiy.blogspot.com/

[economist boy]

in my humble opinion goog will crash one day.
i will be broke by then.

[Victor]

yo henry, what happened to the post-earnings round-up dude?

[billy]

you vick the bull
why dont you figure it out yoself

[Victor]

yo billy - well, i kinda did, i know i won. i just wanna hear henry announce it :)

[billy]

i suppose my guess of 1b revs and an opening price of 150 did not quite get it done??

[Victor]

Danny Sullivan on click fraud:

http://blog.searchenginewatch.com/blog/060725-135832

Henry, where are you?!

[venkat]

Man who slapped a 1000$ target when the company wasn't making a dime talks about Multiple compression
for a company which is earnings billions every year!
Vow times have changed!