Google @ $165
Are These Guys For Real?

Four months after the IPO, Google's stock has soared, the company is selling scads of online ads—and its bosses realize it has to grow up fast.

By Fred Vogelstein

November 29, 2004

[Continued, page 2]

In all its activities Google's goal is to get as deeply meshed as possible with advertising customers. It already handles online advertising for most of the FORTUNE 100, corporate giants with multimillion-dollar ad budgets like Citigroup, Sony, and Wal-Mart. Its ambition is to go further, cataloging every product a big company has and then advertising each one of them with unprecedented efficiency on the web. So if Wal-Mart has too many ceiling fans in some stores, for example, its computers could talk to Google's and automatically trigger a series of ads to interested customers in the right neighborhoods. Sound far-fetched? Google is confident it has the engineering and computer power—thousands of servers running Linux and Google's proprietary software, plus legions of brilliant gearhead programmers—to pull it off. Says CEO Schmidt: "Take any large consumer packaged-goods company. How many products do you think they have? Probably millions, by the time you take into account all the geographic variants. We want every one of those products to be advertised in the appropriate market within Google in the right country and so on."

Few question that Google has terrific tech. But no company grows into a world-beating blue chip on tech alone. Great companies also need great management to keep getting to the next level. Does Google have it?

The unwieldy triumvirate at the top—Google is run by Schmidt, 49, as well as founders Brin and Page, both 31—doesn't necessarily comfort doubters. The company also continues to sport the atmosphere of a dot-com startup, and we've seen how that can turn out. There are few offices at Google, which now employs 2,700 folks, of whom 900 are techies. Brin and Page have an office down the hall from Schmidt's six-by-ten walk-in-closet-sized office, but they share it. The place looks like a dorm room, with roller hockey gear, scooters, and radio-controlled model planes scattered amid two desks, a couch, beanbag chairs, and PCs.

The good news: There seems to be a method to the madness. A majority of the people Google hires—the best and the brightest in most cases—come right out of college or grad school, which is why the company goes out of its way to re-create the life they just left. Says Schmidt: "If you go to the Stanford computer science building, you'll see two, three, or even four people in an office. That model is familiar to our programmers and us because we were all in those offices too. We know it's a very productive environment." Its dining facilities are legendary: Google serves three free meals a day prepared by the former chef of the Grateful Dead. (Judging by the late Jerry Garcia's girth, we don't know if that's a good thing.) It also provides free laundry and banking facilities for its staff. You could literally live at Google full-time; last year, when the company occupied its new headquarters in Mountain View, Calif., some people even tried—until Schmidt told them they were violating the fire code. Google starts meetings at seven minutes after the hour. "It was my idea because that's how college works," Schmidt says. Classes often begin at 9:05 or 9:10.

It's also a good thing—and this ties into Google's ability to innovate—that the company remains notoriously elitist about its hiring, though it is bringing on about 25 new people a week. A team of nearly 50 recruiters divided by specialty combs through résumés, which applicants must submit online, then dumps them into a program that routes those selected for interviews to the proper hiring committee and throws the rest in the electronic trash. Interviewing for a job is a grueling process that can take months. Every opening has a hiring committee of seven to nine Googlers who must meet you. Engineers may be asked to write software or debug a program on the spot. Marketers are often required to take a writing test. No matter how long you have been out of school, Google requires that you submit your transcripts to be considered. The rigorous process is important partly for the obvious reason that in high tech, as on Wall Street, being the smartest and the cleverest at what you do is a critical business advantage.

Even better, Google has done some old-fashioned corporate restructuring. A year ago people who worked at Google, who did business with the company, or who tried to get a job there often left sour. They described Google as a disorganized madhouse run by people too arrogant to be interested in fixing the problems. They darkly predicted that the founders' aversion to standard business procedures and hierarchy would cause Google to implode. Now Google has a head of human resources and three levels of management instead of one; it has divided chunks of the organization into teams organized by product or function. "It has scaled [up] pretty well," Schmidt says.

Some customers still complain. One says that doing a simple deal with Google is harder than doing a complicated deal with Microsoft. But others who used to gripe about Google's disorganization say there's actually been some improvement. A CEO recalls how a year ago Google made him and his negotiating team start over and over with nearly half-a-dozen new engineering reps: "The guy across the table would work with us for two months and then get swapped out for a new guy who didn't have any knowledge of the deal, so we'd have to keep starting from scratch." Today, he says, one person is in charge of his account, and issues get dealt with immediately and professionally. Says another executive who has done business with Google: "They're less arrogant, and they listen better."

Less arrogant, plenty innovative—but is that enough to make Google worth $165 a share? Wall Street analysts certainly think so; 12 of the 25 who cover it rate the company a buy at these levels, and there are no sells (and yes, we've seen this play before too). Believers like Morgan Stanley's Meeker assume the company can continue to grow revenue 25% per year on average for the next decade. Goldman Sachs' Anthony Noto recently assumed that earnings could also rise by a 25% annual rate through at least 2009, which then justified his new "target price" of $215.

Now let's check such math and figure out just where it implies Google might be ten years out. Assuming 20% annual returns from that $165-a-share level (a reasonable investor expectation given the risks), its market cap would soar from around $45 billion today to $278 billion by 2014. That is a lofty height where only a handful of blue chips stand today—GE, Exxon Mobil, Wal-Mart, Citigroup, Pfizer, and Microsoft, to be precise. Dazzling? Yes. Doable? Only if everything over the next ten years goes right.

One company where everything did go beautifully well for a long, long time, of course, was the Google of the 1980s—Microsoft. A happy soul who bought a share of MSFT in 1986 at its IPO was rewarded with a staggering ten-year return of 6,650%, as Microsoft soared from a market cap of just under $1 billion to over $60 billion. That's a gain far in excess of the relatively modest 518% return a buyer of Google today could look forward to, assuming the earnings forecasts of the Notos of this world pan out. Why? Mainly because six months after its IPO, Microsoft still boasted a P/E of only 17 or so. The price back then, in other words, was right, which in turn made Microsoft's subsequent rocketlike growth pay off bigtime. (And lest we forget, the beast of Redmond also enjoyed the unrivaled benefit of that little virtual monopoly over PC operating systems.)

For all its impressive technology and verve, Google, as noted earlier, has no such clear competitive advantage. That may help explain why—as was true during the late, great dot-com bubble—many insiders are rushing for the exits. Three top executives, engineering chief Wayne Rossing, general counsel David Drummond, and human resources chief Shona Brown, said in SEC filings at the end of November that they had sold blocks of stock worth millions of dollars. At about the same time founders Brin, Page, and Schmidt announced plans to sell big chunks of their stockholdings over the next 18 months. Brin and Page said they would sell 7.2 million shares each, or roughly 19% of their holdings, and Schmidt said he'd sell some 2.2 million shares, or about 15%.

History, of course, offers many lessons. Consider one other: Amazon. In December 1999 the company that would go on to change the face of retailing saw its stock peak at an adjusted price of $106.69. Five years later it is trading at $38, having bottomed a few years back at around $6 a share. Which price would you prefer to have bought at? Yet throughout this wild ride, Amazon founder Jeff Bezos was innovating, investing, and building a great company. Google seems well positioned to repeat or even exceed that impressive corporate performance. Just don't bet the rent money on it.

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