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Facebook Inc (FB) and Google Inc (GOOG) Face off Again

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The latest news from Google Inc (NASDAQ:GOOG) is its acquisition of Waze, an Israeli-based mapping company, for nearly $1.1 billion. Waze was almost bought by Facebook Inc (NASDAQ:FB), but eventually Google had the upper hand. How will this acquisition affect Google, and, more importantly, its main competitors Facebook Inc (NASDAQ:FB) and Apple Inc. (NASDAQ:AAPL)? Finally, was this purchase worth it?

Is it an investment or a preemptive move?

Many analysts argue that Google Inc (NASDAQ:GOOG)’s latest purchase is mainly a tactic to prevent its main competitors with Google’s map app. Waze was able to reach more than 34 million users by the end of last year, and some estimate it has more than 40 million by now. This app will most likely reach a much higher number of users in the next couple of years as it links itself with the likes of Google Inc (NASDAQ:GOOG).

Google Waze

Besides this preemptive move, Google Inc (NASDAQ:GOOG) will benefit from the added value Waze offers over Google’s existing Map app. The main added value of Waze is the drivers’ interaction module so that drivers can know from other drivers of any road blocks ahead, accurate duration of drive, accidents, and police monitoring. This will add a great value for users and improve the experience for current Google- map users, but will this app be enough to reach a positive ROI?

Is the price right?

The issue of the price seems also something worth addressing. Purchasing an app for hundreds of millions of dollars isn’t new, e.g. Facebook Inc (NASDAQ:FB) purchased Instagram for nearly $715 million last year. The high price Faceboook paid consisted mostly of goodwill: Facebook valued Instagram at $521 million with goodwill of $433 million; in other words, nearly 83% of Instagram’s value is goodwill. Is it different for Waze?

For a $295 billion market cap company, purchasing a start-up for $1.1 billion won’t appreciate Google Inc (NASDAQ:GOOG)’s value by much. So my expectations are low from this transaction yielding a high return for Google. But is this transaction a good investment for Google?

Waze is currently making around $1 million in revenue (according to estimates; in 2012). Could Google augment this app to generate higher revenue? After all, when Google bought Youtube the company was losing money and now some estimate this website is turning a profit.

So let’s assume Waze will be able to reach a higher market share so that it will have roughly 300 million users in the next couple of years (let’s be generous in this quick back-of-the-envelope calculation.) With an average of $1 in revenue per user this means $300 million revenue. Assuming a high profit margin of 40% with no working capital, loans or other assets, the company’s net profit will be $150 million; based on the above, it will take around 10 years.

In other words the multiplier for this valuation is 10. This is a very high multiplier for such a risky deal. Even if you sweeten this acquisition with “deal blocking” Google’s competitors in the Map-app market, it still seems a high price to pay. Moreover, if a new Map app suffers again in the next couple of years, will Google purchase that company also?

Mobile: High growth, low profits

Despite the high growth in the mobile market its profit margins continue to dwindle. The profit margins of Facebook Inc (NASDAQ:FB) and Google continue to dwindle mainly on account of the sharp rise in mobile market share. Google’s average cost-per-click declined by 4% in the first quarter of 2013 (year-over-year). Google’s profit margins declined from 32% in the first quarter of 2012 to 25% in the first quarter of 2013. Facebook Inc (NASDAQ:FB)’s profit margin also declined from 36% to 25% in the first quarter of 2013.

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