Sucheta Dalal :IT'S DEJA 'GOO'
Sucheta Dalal

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January 15, 2006






WILL somebody please help me on this: Did the whole of Wall Street manage to drop sideways through a trap door in the time and space continuum six years ago?


Apparently so, because I'm either now writing to you from inside John Malkovich's eyeball, or the last half-decade of stock-market history never happened. Either way, it seems we're destined to relive some rather unpleasant recent history — and the moment of reckoning could be closer than we think.


Six years ago, the market's willing suspension of disbelief gave starring roles to America Online and Time Warner. This time around it's Google that can do no wrong.


Last week the cheerleading from Google's proselytizing analysts was all but deafening, as each tried to outbid the other with ever more extreme and bullish forecasts as to where Google stock is headed.


From Goldman Sachs came a 25 percent increase in the analyst's 12-month "target price," to $500 a share. More boldly still, Bear Stearns pegged Google's price at $550 by year's end, while an analyst at Piper Jaffrey threw caution to the winds and went for a year-end target of a full $600.


And anyone hungering for some good old-fashioned shoot-the-moon forecasting reminiscent of Henry Blodget and the worst excesses of the dot-com era, could have placed his money with Caris & Co. That firm's Google analyst offered a target price of $2,000 (though it wasn't quite clear when exactly the wondrous moment would be reached).


What's wrong with forecasts such as these? Plenty — which is why young Master Blodget is no longer a securities analyst at Merrill Lynch and is trying to reinvent himself as a stock market "commentator."


But before getting into the details of what is now happening in the world Blodget left behind, first a bit of background to help remind us as to how even well-run, profitable businesses — which Google certainly is — can nonetheless become rocket rides to ruin . . . not just for individual investors, but ultimately for the whole market.


For those of you who don't remember how we got to where we are now in the stock market — and that would apparently be just about everybody — it was almost exactly six years ago today, on Monday, Jan. 10, 2000, when the airy enthusiasms of the dot-com bull market finally reached the point of total incomprehensibility and even Wall Street's wisest of the wise began speaking in tongues.


We refer, of course, to that moment, captured for posterity at a Midtown press conference, when Gerald M. Levin, the chairman and CEO of the largest media conglomerate on earth, Time Warner, stepped to the microphones to unfurl what will surely be remembered as one of the most astonishingly stupid business deals of modern times.


DRESSED in a sports jacket and open-col lared shirt to show his embrace of the 24/7 "casual Friday" future that now presumably awaited his company, Levin laid out a merger that boiled down to swapping control of some of the most coveted and valuable media assets on earth, for $162 billion worth of bubble-stock in an Internet dial-up outfit with crooked accounting.


And right there next to him at the podium — dressed in his own sartorially confused vision of the future (an actual business suit and necktie) — stood the Brylcreemed young biz-wiz who was apparently going to run the whole business once the merger was wrapped up: one Stephen M. Case.


You will doubtless recall that in the following days, there arose from every quarter such applause as to shake the heavens for the genius of this "win-win" marriage of "old and new."


"We're definitely going to see more of this," cried an excited analyst at Jupiter Communications.


But this was a deal spawned in wishful thinking and self-delusion, and in the months that followed, reality began to break through.


Maybe Levin thought he was driving a hard bargain by forcing AOL to pay a preposterous 71 percent premium over the prevailing market price for Time Warner shares.


Indeed, nothing he insisted on had any meaning whatsoever unless AOL's own share price reflected a reasonable — and reliably stable — valuation of its own.


Yet at an unheard of 166 times current earnings, the AOL shares had long since left the gravitational pull of the Earth and were now winging free in the furthest reaches of outer space.


So it is not surprising that sensible, valuation-minded investors quickly saw the merger as Wall Street's ultimate high water mark in self-delusion, meaning that the market now had nowhere to go but down. And that is exactly what happened, beginning within weeks of that Monday press conference six years ago.


Today we find the same basic theme unfolding all over again, only instead of pie-in-the-sky valuations to support the Wall Street deal machine, we find boundless enthusiasm — and misty-eyed valuations — propping up a single company, Google, that in turn is pretty much propping up confidence in the entire market.


For a sense of the prudent, dialed-back analysis that is going on here, consider this gem from a recent Bear Stearns & Co. report on the stock. The report claims that Google is evolving into an entire Internet "ecosystem" and that its net revenue growth of 183 percent yearly since 2001 amounts to nothing more than "pressure waves before the real tsunami."


You can find lots of graphs and charts and steeply sloped growth trends in reports such as these, and plenty of heady arguments that Google is growing faster than Microsoft ever grew at a similarly early stage in its life.


But there's one thing you're not likely to read about in any bullish report on the stock: Though Google's net income is growing faster than its top-line revenues (a fact that is almost always pointed out by bullish analysts), roughly 10 percent of that net income (and maybe quite a bit more than that) appears to be coming from paying the company's employees in stock instead of cash.


What's more, those payments have been taking place under accounting rules that sharply reduce the portion of the awards that have to be treated as expense items on the company's income statement, thereby reducing costs while boosting net income.


There is language in Google's most recent quarterly financial report warning that these rules are about to change, and that beginning this month, the company's net income will show a resulting downward adjustment. The adjustment appears to work out to at least a $100 million haircut for 2005 earnings, or about 40 cents per share.


That may not seem like much for a company that analysts think will wind up reporting close to $5.90 per share when the September-December quarter is finally toted up. But it means that although Wall Street doesn't yet seem to realize it, Google is already selling for close to 85 times 2005 earnings, as well as an even more sky-high price of 209 times cash flow from operations — and those are startling multiples to say the least.


To be sure, none of this means that Google is a bad company with crooked accounting. Quite the contrary, the company is not just profitable and fast-growing, but its financial reports spell out the potholes in the road ahead in ample detail for anyone to see.


What the numbers do mean is that this is a company for which its own audited financials no longer seem to matter one way or the other. Instead, what matters for Google now is the same thing that mattered for America Online six years ago — and for so many other companies before even then: The capacity of investors to convince themselves, against the weight of all evidence to the contrary, that trees really do grow to the sky, and that no good stock can ever go down.


Sooner or later, they all find out that this is simply not the case. And if Wall Street keeps bumping up its Google forecasts the way it has been doing, we are likely to see that day come upon us sooner than anyone expects. So, what else is there to say but, beware!


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-- Sucheta Dalal