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

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[someone]

everybody has forgottent hat google has been
investhing this year in perfomance, such as
ordering a SUN blackbox and making the whole
google plex a solar panel, this on the long term
will make them more and more money, one current
problem for google is the energy that they consume
wich is outragously high having in mind the amount
of computers that they are running. so dont
be confused kids by google profit drop, at one point its going to be 4 billion all of the sudden.

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[iknowall]

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