Google - Ever reaching a $1000?

Not so long ago the stock was at $700, now it's a $450 and trading lower along with the entire stock market. Is it a steal at these levels? Lets see.

Google has been putting out a lot of cool products out there: google maps, gphone, new browser... But the financial story remains all about online advertising and its penetration which currently stands at 8%. The key questions are: 1) what will this level be globally and in the U.S. 2) what is the overall advertising growing at? 3) What is the consensus expectation for 08-10 growth and what will actually happen.

Addressing the long-term issues first. Advertising share of GDP has been pretty constant at 2.0-2.3% since 1980s, so ad just grows at GDP lines long-term (actually slight lag in the last couple of years, but lets consider that noise). The GDP growth is 3% real + 2% inflation, so lets 5% long-term for ad spend.
The penetration is 8% now. I've heard numbers up to 15% in the next five years, lets take 12% by 2013. Currently U.S. ad spend is projected to be $297B for 2008, at 5% that's $379 in 2013. Internet is projected to be $25B in 2008 (8.4% penetration), at 400bps increase that's $47B in 2013 or 14% CAGR. Sensitivity? Each 1% in penetration = 350bps of CAGR. Quite a bit.

Now to short-term questions. Historically advertising is a high-beta play on U.S. GDP - although the long-term growth for both is the same, ad spend has fallen in the last two recessions (-1.2% in 1991, - 6.5% in 2001). The effect is typically lagged by a year because the 2008 budgets a while ago so do not incorporate the new economic outlook. The analysts however expect the recession to not impact advertising very significantly this time. They're saying in 1991 companies cut budgets and chose to focus on value which was proved to be an error, while in 2001 the recession was corporation vs consumer based? Perhaps I buy the first argument but not the second - consumer trickles down to corporate eventually. I think a particulary vulnarable area is Internet advertising that dropped 12% in 2001 and 16% in 2002. The analyst would rebut this by saying the area is much more mature now, companies are convinced or internet value, and look at the latest number - 16% growth in q2 2008 (bernstein tracker) while overall market is down 2%. I partially agree with all this. At the same time, I fear that a lot of the businesses advertising online a inherently lower quality than those using TV for example (low entry cost), and they're the ones that get squeezed the most in the tough economies like this one. So I'm cautious on the outlook, and think the 2009 online growth will likely be around 8-10%, below expectations. This is below expectations and seemingly a recipe for the fallout in stocks.

As for Google itself, the company faces several issues that I think raise a pink flag for me: increasing acquisition costs (TAC) that may be offset by decreasing R&D spend but operating margin improvement expected by the analysts strikes me as too optimistic. Second there's the competition from MSFT/YHOO, and third is the rising capex.