China exit may be a setback for Google’s strategy, stock

Leaving China will close key avenue of future growth

Reuters
22 March 2010

An exit from China’s search market could mark a setback not only for Google Inc’s global business strategy but for a stock that has long been synonymous with virtually limitless growth opportunities.

After nearly six years of tantalising Wall Street with its unbridled potential, Google is for the first time threatening to close off a key avenue of future growth if it shuts down its operations in China, the world’s largest Web market by users.

For the investors that have long celebrated Google’s status as one of the tech industry’s leading growth stocks, the situation in China is cause for some re-evaluation.

‘It hurts the multiple people are willing to pay for Google if they don’t have the China opportunity,’ said Aaron Kessler, an analyst at Kaufman Brothers.

Since Google said in mid-January that it intends to stop censoring search results in China, the stock has fallen roughly 6.3 per cent, closing at $560.0 last Friday and wiping away about US$11.6 billion in market capitalisation. During the same period, the Nasdaq has gained 3.4 per cent.

The Google sell-off occurred even as Wall Street’s near-term financial expectations for the Internet company have improved. During the past two months, the average analyst estimate for Google’s revenue and earnings per share next year have risen 3.1 per cent and 2.3 per cent respectively, according to Thomson Reuters StarMine.

Google dominates the search market in the US and most other countries in the world, but it is a distant second in China, where local powerhouse Baidu Inc is the top dog.

Since Google’s announcement that it could pull out of China, Baidu’s shares have surged 44.5 per cent.

Baidu trades at 41 times forecast 2011 earnings, whereas Google trades at just under 18 times next year’s earnings.

China already has more Internet users than any country and will become the world’s largest online ad market at some point, said RBC Capital Markets analyst Ross Sandler.

‘So walking away from that upside is a real problem if you’re Google and if you’re a Google shareholder,’ he said.

To what extent Google walks away from China is still unclear.

Google has been negotiating with the Chinese government about operating an uncensored search engine in the country, but few expect it to succeed. A report in the China Business News last week said that Google could make an announcement about its future in the country today.

Many analysts believe that Google will seek alternative ways to play in the Chinese search market even if, as it seems increasingly likely, the company opts to pull the plug on Google.cn, its censored Chinese-language search site.

It is possible that Google could create a new Chinese-language search site based outside mainland China and the government’s strict regulations about acceptable content. As it is, Web surfers can already get localised search results for various countries, translated into different languages including Chinese, directly on the flagship Google.com site.

Of course, only the tech savvy in China can access sites based outside the country and its Web filtering firewall.

And it’s unclear to what extent Chinese advertisers would be able to access the self-service ad system that Google offers.

‘Obviously the opportunity is smaller without Google.cn, but it’s not zero,’ said Pacific Crest Securities analyst Steve Weinstein.

Google’s Android smartphone operating system is also likely to play a large role in the company’s future in China.

While Google gives Android away to cellphone manufacturers for free, the software provides a way for Google to reach consumers directly and to potentially offer ads and other money- making services that are not as politicised as search.

Google’s current business in China accounts for a tiny slice of the company’s US$24 billion in annual revenue. Analyst estimates of Google’s annual revenue in China range from US$300 million to roughly US$600 million.

While the situation in China is a setback to Google’s long-term business goals, some analysts said that the company has enough other opportunities to retain its status as a growth stock.