The Global Perspective - Market Leading Commentary On The World Economy

At Last Some Smart Thinking On Google In China

Bill Thompson from the BBC on Google in China:

"Forgive me if I refuse to go along with the knee-jerk consensus on this one.

"Millions of people may now be turning away from Google in disgust, but I've just reinstated them as the default search for my Firefox toolbar, because I think it should be supported for its brave decision.

"Even if the primary motivation for going into China is that it makes commercial sense for the company - as indeed it must do, since US law is quite harsh on boards that take actions which could damage shareholder value - it also makes political sense.

"Supporters of free speech and open societies should be supporting Google rather than lambasting it.

"But if we in the West, with our liberal political culture and our attempts to build open societies, do not engage with China then we lose the opportunity to influence them and convince them of the benefits that this brings. If the Chinese government fears instability then we should offer help and advice and support, not closed borders and locked doors."

Finally, someone who is using their head on this one. This is precisely what I've been saying all along.

Bureaucratic Demands

Google's response to the U. S. Department of Justice demanding disclosure of two full months’ worth of search queries that the company received from its users, as well as all the URLs in Google’s index:

"Google is, of course, concerned about the availability of materials harmful to minors on the Internet, but that shared concern does not render the Government's request acceptable or relevant. In truth, the data demanded tells the Government absolutely nothing about either filters or the effectiveness of laws. Nor will the data tell the Government whether a given search would return any particular URL. Nor will the URL returned, by its name alone, tell the Government whether that URL was a site that contained material harmful to minors.

"But, the Government's request would tell the world much about Google's trade secrets and proprietary systems."

This response exemlifies all the types of things government departments get wrong when they issue subpoenas towards institutions that operate in technical niche industries. By being so general in stating the reasons why they need the subpoena, government ministers play into the hands of the employees who spend twenty hour days and six day weeks operating the intricacies of the industry.

The same thing has happened a number of time in obscure areas of the financial markets: bureaucratic departments bark out demands which highly-paid quantitive employees of the banks cooly refute, phrase by phrase, until it is legally irrefutable that any of those demands be met.

What Happened To American Optimism?

An erudite but ultimately exhasperating piece on Google in China yesterday appeared on the Becker-Posner blog:

"Last week a congressional committee questioned representatives of Google, Yahoo, Microsoft, and Cisco concerning Chinese censorship and surveillance of Internet services (and in the case of Cisco, equipment) provided by these companies.

"... In general, U.S. companies, including Internet companies, are required to comply with the laws of every country in which they operate. Thus, for example, they have agreed to block access, in France and Germany, to Nazi Web sites, pursuant to those countries' laws against Nazi advocacy ... Of course there is a difference between foreign laws that we regard as defensible, including some laws, such as those forbidding Nazi advocacy, that would be unconstitutional in the United States (which has by international standards an extravagant conception of freedom of speech), and laws that we regard as contrary to fundamental human rights, which is an accurate description of Chinese laws designed to suppress political freedom and, in the case of persecution of the Falun Gong and of some Christian sects, of religion as well.

"If China were a small, poor country, its violations of human rights might induce international sanctions, such as were imposed on Rhodesia and South Africa before the fall of their racist regimes. But because China is an enormous country, rapidly developing, soon to be--perhaps already--the second largest economy in the world, and very much open to investment by foreign, including U.S., companies, sanctions are out of the question as a practical matter.

"... The deeper question is whether it is in the U.S. national interest either to promote Chinese democracy, religious freedom, etc. or to impede Chinese economic growth by inducing it to curtail its people's access to the Internet beyond the current censorship. The answer probably is "no" ... A possible intermediate solution, however, would be to forbid U.S. economies (or for them to agree under pressure of American public opinion) to assist the Chinese government in surveillance of their customers."

Let me try and put some of this beligerant - ableit intelligently written - rhetoric into perspective for Judge Posner. I have argued here before that Google's entrance into China is a positive step in the right direction as far as implicating the spread of democracy by western standards is concerned, and for a very good reason. If His Honour cared to take a quick glance at Chinese history, he might begin to notice a pattern that has been emerging over the last three decades: that namely, the political structure of China has become increasingly capitalist in its modus operandi.

This is not down to any coincidence - one of the central reasons Deng Xioaping was able to begin the process of opening specialised regions of China (Special Economic Zones) to foreign investment in the early 1990's was precisely because the environment had been created by the gradual infiltration of capital that had already been coming from outskirting territories such as Hong Kong and Malaysia for years before. Those investors who initially placed capital in the hands of former Mao-Xedong's China most certainly had to accede some personal ethical issues, but the point is, the accession has proved worth it in the long run: over a very short space of time, China has become a more liberal, more democratic environment than any pundit could have ever reasonably speculated twenty years ago.

Posner misses the point supremely in even contemplating the idea of sanctions: it is precisely the opposite effect of having not talked of sanctions whatsoever, but constinually excercising patience with regard to China's liberalisation of Communism which has brought about the phenomenal changes that can be witnessed today.

The simple, undeniable truth is that the more Western companies that enter China, the more China accepts by default a western political modus operandi. This is the most basic-level sociology: organisations the size of Google have two critical components of influence - a culture, and lots of capital. What has been so disheartening in all the recent fuss the United States has been making over the entrance of its national institutions into China is that the constitution was founded on principles by Adam Smith, the father of the ideology around this governing capitalist principle.

If Posner and Congress are still unconvinced, they should take a trip to Hong Kong. Hong Kong is not the great capitalist power-house and pearl of democracy in the Far East it is because of the hesitance of Western corporations in the twentieth century to enter it: it is precisely the way it is because these organisations embraced concessions and in doing so were able to make progress in changing cultural trends. Sure, Hong Kong is a former colony of Great Britain, but in an actual sense, this didn't translate into much of a competitive advantage - western organisations had to persuade their Chinese consumers - who came from a completely alien culture - that what they were selling was worth the price they were asking.

If, after all of the above, Congress is still so concerned with the entrance of its national institutions into China then maybe it should ask itself why it has allowed Beijing to store all her national capital reserves in U.S. government bonds. Posners suggestion is just untenable: the U.S. can hardly forbid her economies to assist the Chinese government in surveillance of their customers whilest using all her excess capital to prop up its own growing national deficit.

The irony is that it is the same right-wing religious contingency that allowed this capital surplus to develop in its coffers in the first place that now wants to stem the tide - unfortunately for them, as the old Wall Street addage goes, there's no such thing as a free lunch.

Change in China

Recent emotional outbursts like this one by Glen Reynolds of Instapundit to Google’s decision to self-censor in entering the Chinese market are not only naïve, they show a complete lack of understanding of how global trends work. The infamous blogger and author of “An Army of David’s: How Markets and Technology Empower Ordinary People to Beat Big Media, Big Government, and Other Goliaths” quotes a recent Wall Street Journal Article: “Executives from Google Inc. and other Internet companies head to Capitol Hill next week, where they will become feature players in an awkward debate: Are U.S. companies giving in to China too easily? Last month, Google announced an agreement with the Chinese government to censor search results from its Chinese site. It was the latest Internet company to accede to the Chinese government's censorship restrictions, following Cisco Systems Inc., Microsoft Corp. and Yahoo Inc.”

Reynolds concludes: “I hope they find the eperience (sic) embarrassing.” This kind of paranoia is somewhat reminiscent of the days of the petty U.S.A./U.S.S.R. disputes, all which ultimately proved destructive and futile. Perhaps the law professor and the members of this week’s Capitol Hill committee should attend a quick history class and think about what the title of the former’s new book is saying, for if they did, they might notice how frequently self-censorship by organisations who in the past have tried to enter politically controversial markets results usually not in the ethical aberration of the organisations, but actually in changes to that nation’s marketplace. Supporters of the spread of the Western policies of free speech and low censorship should welcome actions like Google’s in entering China with some constraints, because they are the best real attempts that can be made to change the political landscape of emerging economies.

Take a recent New York Times article picked up by Hong Kong website “Simon’s World”, entitled “Ex-officials protest censorship by China”. “A dozen former Chinese Communist Party officials and senior scholars, including a onetime secretary to Mao Zedong and the retired bosses of the country's most powerful media outlets, have denounced the recent closing of a prominent newspaper supplement and helped fuel a growing backlash against press censorship in the one-party state,” reports Joseph Kahn. “Propaganda officials are also facing rare public challenges to their legal authority to take such actions, including a short strike and a string of resignations at one newspaper and defiant open letters from two editors singled out for censure.”

The piece concludes; “Those protests suggested that some people in China's increasingly market-driven media industry no longer fear the consequences of violating the party line.”

Reynolds is not the only one to be making such a fuss over the Chinese issue: almost unanimously the media have cried foul over what they perceive as mal intent by “the worlds’ most philanthropic company,” but the critics miss the point. Changes like those described above are brought about because of organisations like Yahoo! And Google, who are willing to concede on the grounds of some preliminary home-country moral issues in order to make progress in implementing their wider philosophies onto the global stage. Only by “doing as one does in Rome” can one reasonably expect to make progress in implementing policy and cultural change there.

Fiscal Philanthropy

… And so it’s Bill and Melinda Gates, Time Magazine’s “people of the year”. The U.S. popular culture weekly declared boldly before Christmas: “Imagine a kinder, humbler Microsoft – one designed to spend money, not make it. That’s the kind of philanthropy Bill and Melinda Gates have invented.”

The award – spread over more than ten pages – features a pretty thorough investigative piece about the couple’s foundation and work with musician Bob Geldof in conquering the battle of poverty and H.I.V. in the developing world, most revealingly shedding an interesting light on the billionaire who gave the world the software standardisation that led us into the twenty-first century.

In November, this blog published some crucial errors of judgement in forecast, for which exposure and further analysis is surely the only remedy for correction. It all started with a piece titled “In Search of the Future: Google Vs. Microsoft”, which analysed the two companies from a financial perspective and concluded that with a price-to-earnings multiple of nearly five times Microsoft’s, and a valuation of less than half the Redmond giant’s, Google looked perilously overvalued. The overwhelming popularity of that piece spawned perhaps more “from the hip” and less thought through articles such as “Google Noise, Industry News” and “Time For a Hatrick?”, a by all accounts dismally unpopular piece about how Chairman and Chief Executive Dick Parsons was likely to sell a five percent stake in AOL to Microsoft rather than Google which “will have the effect of restoring some rationale back in the NASDAQ”. The latter analysis not only ultimately ended up as the direct opposite what happened, but quite shamelessly ignored the fact that Google and America Online had been in cahoots for an “internet century” in linking ad’s and searches to one another.

The net result of all the criticism late this year has led some to believe that the sole purpose of this blog is to denounce the meteoric rise of Page and Brin’s NASDAQ darling. For purposes of official clarification, then: it is not. In retrospect, I should have left the commentary to the pundits after the gratefully received rationale documented in “In Search of the Future”: it was a powerful piece, and contained some considerable truths based on nothing other than hard market data, and it still holds true. The irony is that what appeared to be continued Google-bashing from “The Global Perspective” ultimately detracted from all the valid insight that went into the first piece. In the interests of face-saving, I return now to more considered analysis.

Philanthropy Acts

The question is, what to make of the aftermath of AOL’s five percent garage sale to Google, which was considerably lower than expectations? There is a lot of speculation about the “end of Google ad’s” as pundits worry about the confusion the link between the two will create and images that will now appear in Google ads, but this criticism misses the point. Google has been destined for a fall in equity value for some time now, and as easy as it will be construe AOL as responsible for this, the sale is quite unrelated.

This December, I had the priviledge of attending a seminar by Jan Grönbech, Head of Google Norway. When I put to him his view that Google stock “still had a long way to go” at a P/E of over 90, his reply was succinct: “What was Microsoft’s P/E in the early 1980’s?”

It’s a fair point, and needs publication in light of the above, but the scenarios are different, not least because there is no clear fiscal resemblance between the market climates of the early 1980’s and today. No doubt much of this is generated as a result of Google’s unrivalled reputation right now as “the best possible place work in the world”: after all, this is the organisation that in hurricane Katrina whose founders Page and Brin went one better that the Commander-In-Chief of the world’s formidable superpower and personally airlifted employees and employees’ relatives alike out of devastated areas of the United States at considerable cost to themselves.

Such compassionate corporatism cannot be overlooked, and should not, but in light of the recent Time expose, raises some critical indicators as to the momentum behind Silicon Valley and Redmond, Washington prioritisations. Many a corporate billionaire, in search of the elusive meaning of life, has opted for semi-retirement and saving the world rather than focusing continued entrepreneurial energy on building an already gargantuan enterprise, only to see the latter suffer as a result: while financier George Soros has been out saving the Eastern European education system many a nimbler hedge-fund has posted gains far beyond anything the Soros and Quantum funds have come up with. The key difference between Microsoft and Google is that it seems to be the case that while Gates’ energy is now turning increasingly to the Bill and Melinda Gates Foundation, Google has the advantage of two energetic founders who are throwing all their philanthropic resources into the creation of their baby, which is creating some credible reactions to the latter an some acts of revulsion to the former.

Such growth by competitors is misleading however, for the fact remains, no amount of goodwill or philanthropy can substitute for real financial variables. Just as for the case of dynamic hedge funds that post seventy percent returns year-on-year, the gains against the size of the organisation is as much an indicator of risk management as it is of successful performance. Such competitive processes can have a deceiving effect, for while product/feature maximisation takes off with some degree of awe-inspiring alacrity, the same cannot be said for the variables that underlie the speculation that is surrounding the enterprise, and by that measure, Microsoft looks good. By all means buy Google ads, but not the shares.

Hindsight

A popular current affairs blog called “YARGB” yesterday picked up on a piece on this website titled “In Search of the Future: Google Vs. Microsoft, offering that “you might want to read this article on why Google's shares are overvalued.” 

Those who take shots at hyperbole should inevitably expect to take some flack. So it comes as no particular surprise then to find some irate reactions to my take on the overvaluation of Page and Brin’s stock market darling. One reader, who goes by the name Doug suggested that “I only wish I could go long Google and short 10 times as much "Daniel M. Harrison" stock for a no-lose play”. The lambasting continues: “Mr. Harrison strikes me as long on hubris, and short on knowledge of what has brought Google to this point, believing Google's position is to a substantial degree based on hype. I'm confident this describes him better than it does Google.”

But the criticism missed the point. It was not here that I was critical of the company’s strategy; for sure, Google makes for an amazing start-up success story. I was merely pointing out that what market participants have forgotten in all the mania is that running a public company with a board and a list of shareholders to whom one holds oneself accountable and a host of day-traders continually exerting pressure on the stock price – and as such, company capital – requires a very different strategy to running a private company free of the scrutiny of the latter greedy camaraderie. As a CEO, a market rally is great while the going is good, but quite the contrary when market forces turn against you.

Either way, I expect the arguments are just semantics to the belligerent crowd. For it is all too often the case that criticism of mainstream thinking turns out to be right at the time, but the participants just don’t want to acknowledge it. A year later, of course, it’s relegated to hindsight.

CEO’s of public companies these days ought to be careful about how they let their stock rally – after all, it’s still only recent history the days when disgruntled investors came banging at the (in some cases, jail-cell) doors of top management. For when things turn against them, those who so defiantly refused to see the downside in the good times take it more personally than CEO’s could possibly realize.

Industry News, Google Noise

When news starts to sound like noise it’s usually an indicator that hype is clouding the reality of events. It’s difficult not to see the auspiciously named News.com’s appraisal of Google in yesterday’s article “What you get for $400 a share” as exactly this, and it should serve as a warning for those who are invested anywhere near the current price.

It’s easy to forget about the industry potential of any company but Google and overlook other newsworthy items with all the current hype surrounding the search-engine goliath, but some alternative analysis might well pay off.

Take TiVO, the low-key U.S. manufacturer of live television streaming boxes and yesterday’s announcement on the rather more credible news provider Reuters that it was “working on technology that lets viewers search for specific advertisements … (that) would begin testing a feature to let some subscribers transfer recorded television programing to Apple Computer Inc.'s iPod digital music players”. Uneventful as this might sound aside such mesmerising commentary by News. Com that “Google will no doubt figure out a way to charge for (free services) so it's not so dependent on advertising … (being) the "it" tech company of the moment”, the former is at least a statement of actual strategic intent.

A partnership with Apple computers is a smart way to leverage the brand equity of a company one-twenty-fifth of Google’s size with the capability of a company three-quarters of the size and with a price to earnings ratio in the market of half the Mountain View empire’s at a time when the latter now looks overpriced by any reasonable financial calculation (see In Search of the Future: Google Vs. Microsoft).

What the above signals is first-mover advantage in the as yet undominated computer-television market, a lucrative source of advertising revenue for those who manage to get in on the act. And TiVO, by all accounts, has plenty of experience: this was a company, after all, which entered the market in the bull-market hype of the millenium and who, despite having yet to make a profit, has weathered all the possible storms a company could in a bear market. Google, as I have stated here before, is a rookie to the NASDAQ, and its showing.

Investors should be well aware by now that past performance of an equity’s share price is certainly no indicator to future performance of the stock, and neither is it to the actual state of the company. Amidst the clamourous gong of all the noise, it's all too easy to overlook the news that makes tomorrow's headlines.

In Search of the Future: Google Vs. Microsoft

Since last year, the Google Phenomenon has been creeping steadily into all factions of society, from the broadsheet financial papers right down to the teenage magazine weeklies, making Larry Page and Sergey Brin household celebrities worth billions of dollars and determined to change the way everyone works, plays and interacts over the next decade. When even notoriously “anti-American corporate” French periodicals start declaring the rise of U.S. companies, you know something’s going on: only last week, Le Point featured both founders on the front cover and declared boldly inside: “L’ambition de Google parait n’avoir aucune limite” (the ambition of Google seems to recognise no boundaries).

Suddenly everyone everywhere is talking about Google teaming up with Sun Microsystems, who has come obligingly out of left wing, to possibly create the most advanced new desktop software around, making a challenge to the Windows standard. And Google is laying the groundwork with numerous Beta test applications, taking on everything from academia (Google Scholar) to e-mail (Google Mail) down to internet chat and VOIP communications (Google Talk).

But how credible are these threats? Certainly the savvy invitation-only launch of applications such as GMail and Google Talk has elicited some favourable press, and the functionality and usability of its Beta launches has been extremely well received by both the public and by technical critics, but could this innovative relative newcomer really take on Microsoft? Many seem to think so.

While there is a lot to be said for the weighing up of the technological merits of both companies' capabilities, how about looking at it from a purely financial perspective? After all, as history has continually proven, a specification war is not only won on the technilogical superiority of a comapny's product but on its muscle in the fight. What most people seem to have forgotten in the midst of the Google hyperbole are the fundamentals behind the two companies. Google has a reputation for being very secretive, something that has been, again, well received, while Microsoft’s very public announcements appear to be going in one ear and out the other of most analysts. But is Google really that secretive? The company is touted almost weekly in one broadcast or another as “changing the world” or “knowing no limits” or “never ceasing to adapt”, and one has to posit, with this much excitement in circulation, does Google really have nothing at all to do with all this?

It would be naïve to think not. Furthermore, a closer analysis of the company’s share price since the IPO last year seems to give way to more suspicions about the apparent ‘secrecy’ Google encloses around its HQ in Mountain View, California. The company is now trading at nearly four hundred dollars a share, or, in real value, at a P/E of 85! The last time this kind of valuation was seen anywhere near the NASDAQ was back in the heydays of the tech bubble. To believe that this kind of price performance in the current market climate is achievable without a heavily active PR department is somewhat risible.

The more “extrovert” Microsoft, by comparison, trades at only a fraction of this price, at a P/E ratio of just over 20. In addition to this, while Google is worth just over $100 billion dollars, Microsoft is worth $250 billion. This comparison alone makes Microsoft extremely good value and Google way overpriced by any measure, espcially with Microsoft's earnings up on the year to date.

It is easy to take cheap shots at Microsoft because of its gargantuan monopoly, and undoubtedly, it makes for great news when a young upstart takes top lead over a franchise of Microsoft’s size. But for all its evils, Microsoft has consistently delivered us into the world we now know and use: from the desktop to the application I use to write this article on, to the software that enables me to broadcast it out to a planet of six billion people, Microsoft has provided by far the bulk of the platform.

What is interesting however, despite the potential Microsoft-Google wars, is that all this publicity signals a demand from the world at large for some kind of change of the current software standardization. A lot of Microsoft’s success depends on whether its next foray into the market, Windows Vista, can provide a sufficient enough change to satisfy the demands of customers tired of filing by a limit of subject and surfing by a limit of criteria.

Because, contrary to public opinion, it looks like Google might have over-sold itself too early. A P/E ratio at its current level cannot be sustained for an indefinite period of time. The only way that Google can possibly sustain this kind of price to earnings valuation is to actually deliver a viable desktop software before Microsoft comes out with its challenge next year. If it doesn’t, and the price of its shares starts to fall (as it surely will), Google is going to find itself having to split its current stock in order to attract more investors to its equity, a strategy that could lead it to decline further. Capital withdrawal from shareholders at the moment of a head-on confrontation with a monolith such as Microsoft can be disastrous to the outcome, particularly when Microsoft is sitting pretty right now at a relatively low industry valuation. Microsoft has been a public company for long enough to know the tricks of the trade that rookie Google still has yet to acquire: Page and Brin should be careful where they tread.