Google's MySpace Deal Is Better Than Reported

Google Inc. (GOOG) and News Corp. (NWS) announced a deal on Tuesday for Google to provide search and advertising to almost all of Fox Interactive's Web sites, chief among them MySpace. The market reacted favorably, driving up Google's price by more than a percentage point, even after a 1.1 percent gain on Monday following Google's announcement of a partnership with Viacom Inc.'s (VIA) MTV network.

Our analysis shows, though, that Google remains fairly valued.

This latest deal is potentially much bigger than the news reports might lead the casual reader to believe. Most headlines, including that of our Reuters report, pointed to Google's teaming with MySpace. MySpace is undoubtedly the big fish in the Fox Interactive pond in terms of traffic, but their other sites are no slouches. Among the sites that are affected by this deal are the IGN sites, the Gamespy sites and Rotten Tomatoes, among others. The lone holdout of the Fox Interactive stable is FoxSports, which has been teamed with Microsoft Corp.'s (MSFT) MSN since 2004.

Furthermore, the terms of the deal with News are that Google will make minimum revenue sharing payments of $900 million to News Corp from 2007 to 2010. In other words, if MySpace and other Fox Interactive sites are better monetized thanks to Google — a distinct possibility given Google's advertising track record — both companies could make much more than this minimum figure.

Also intriguing is the idea that both companies left open the possibility of further partnerships. Video sharing, in particular, is not part of this agreement, but given Google's Monday announcement, it doesn't take an analyst to speculate at what a future Gen Y Internet powerhouse could develop if Viacom was to specifically join this alliance.

The question for investors is whether Google's shares still have room to grow. The consensus per-share earnings estimate for Google today is $9.88 per share for 2006, with 35 analysts opining in a range of $10.56 to $9.00. As of this writing, nine analysts had reiterated their estimates, though, and the average of their estimates is $9.99 in a range of $10.17 to $9.80. The average estimate for long-term Google earnings growth, meanwhile, is 35.4 percent, with 18 analysts weighing in in a range of 61.8 percent to 23.0 percent. Of the seven who had updated to this point, the average is 35.3 percent, with the most bullish projection at 48 percent and the most bearish at 30 percent.

Google's history isn't long enough to have an "official" beta, so we'll use the computer services industry average beta of 1.6 as an input into our capital-asset-pricing model. We also used a price-to-earnings-to-growth [PEG] ratio of 1.1, about where Google was trading pre-announcement. The model indicates that with these inputs, and using only the newest earnings estimates, an investor in Google shares today would need to see per-share, annualized earnings growth of 35.6 percent to break even.

Looking at either the official consensus of 35.4 percent or the average of today's updates of 35.3 percent, the shares are formally overpriced. Given the tight difference between the figures, though, we'd treat the shares as fairly priced. The sheer magnitude of potential growth suggests the price may be right for growth seekers.

GOOG 1-yr chart:

At the time of publication, Paul DeMartino did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.