Are the glory days over for Google?

published 18 April 2008

Google's sky-high share price has wobbled in recent months, and key executives have headed for the door. Are these the first signs of the decline of Google? Simon Wilson reports

How dominant is Google?

When it comes to web search, Google (GOOG) is the undisputed champion. The yawning gulf between it and its rivals is amply illustrated by Microsoft's (MSFT) $44bn bid to buy up Yahoo! (YHOO) and create a serious rival to Google in the sector. Microsoft's ultra-aggressive boss Steve Ballmer has made it his stated ambition to "kill Google" and "bury" its chief executive Eric Schmidt. To do so, he is playing hardball, threatening tactics aimed at pressuring Yahoo! to do a deal fast.

But even if Ballmer is successful and he probably will be a combined Microsoft/Yahoo! would still have just 15% of the global search market compared with 62% for Google, according to figures from data firm comScore. Here in the UK, Google's dominance is even more assured, with an 80% share of the market.

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Could Google really be in trouble?

Its share price certainly is. On 6 November last year, Wall Street valued the firm at an all-time high of $742. Since then it has lost some 40% currently trading around $450. In part, that sharp slide is attributable to general market turbulence and the fear that any advertising-based business is vulnerable during an economic downturn but that's far from the whole story.

Plenty of analysts and commentators (including MoneyWeek) have been arguing for years that Google's stock price was grossly inflated and could not be justified by any realistic projections of future earnings. In the past month or so, the first indications that a fast-growing Google was not an inexorable law of modern business have seen confidence tumble.

Why, what happened?

Three things. First, the firm reported revenues in the fourth quarter that were lower than Wall Street expected. Second, two reports from comScore showed that the number of users "clicking through" to paid-for adverts flatlined for two months running, compared with annual growth of up to 40% just six months ago. (Google says this is the result of a tweaked strategy it wants fewer but better-quality clicks and is expected to expand on this when it announces results this week.)

And third, a trickle of senior executives have chosen to leave the company, worrying the market about Google's ability to hold on to its best and brightest. Sheryl Sandberg, who built the key revenue generators AdWords and AdSense, quit for Facebook. Then Doug Merrill, seen by some as a potential future boss, quit to take on the challenge of turning around struggling music group EMI.

Is this much ado about nothing?

It could be. Analysts expect first-quarter results to show revenues climbing 40% to around $3.5bn, with profit per share up 22% despite last year's hiring binge and higher R&D spending. That does not sound like a company in trouble. But the market is spooked by signs that Google is maturing into a rather unfocused company. In the US, commentators have made much of the fact that Fidelity's two biggest funds have been selling down their stakes in Google; if Fidelity managers have stopped believing in Google, the thinking goes, then maybe there are real problems there.

What are the problems?

First, the ongoing brain drain' is not a trivial distraction but a central business issue for Google see below. Second, there's a growing perception that the firm's growth strategy everything from online video ads and office software to wireless communications is a scattergun approach that has not yet established any meaningful new revenue streams. From GoogleEarth to Virtual Worlds, what was once perceived as a simple search engine has become a complex web of businesses, evoking memories of Yahoo!'s own all-things-to-all-people ambitions. Third, superior search technology will not protect any company during bad economic times, especially one whose principal business is advertising and advertising based on complex mathematical formulas at that.

So could Google be toppled?

It certainly faces stiffer competition, in large part due to its own expansion plans. Last year it began offering software programs online (such as email and word processing) in direct competition with Microsoft. It has moved strongly into video-sharing and display advertising with its $1.6bn acquisition of YouTube in 2006 and the recently completed $3.2bn deal for DoubleClick. As BusinessWeek notes, in each of these areas Google faces "credible and often large competitors" not something that the firm is used to in the search sector.

Most of all, as it broadens its ambitions from search into software, the business faces a Microsoft that has been in "kill Google" mode for well over a year, spending billions on ad-related acquisitions even before its audacious attack on Yahoo!. One thing is certain: there are interesting battles ahead.

Why is Google suffering a brain drain?

Since long-time staff were able to cash in the last of their pre-float share options last year, it has been open season for poaching Google engineers and executives. Typically, these are highly motivated individuals, already wealthy from their stock bonanza, who relish fresh challenges. Silicon Valley blogs are full of lists of Googlers who have jumped ship for start-ups or competitors.

Meanwhile, newer employees face a rather different dilemma: the tanking share price means they now hold stock-based grants with strike prices above the current share price. If they don't think the stock is heading back north, they, too, may be hard to retain.