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28 September 2004

Americas/United States
Consumer Internet
Equity Research

Google, Inc.
Initiating at Outperform and $145
Target

We initiated coverage on Google with an Outperform rating and a 12-month target price
of $145. In its relatively short operating history, Google has grown into the fourth most
visited site on the Internet and the dominant search engine with more than 50% share.
We forecast that Google will be able to continue to grow revenue by roughly 50%
annually over the next five years and earnings by over 30%. For 2004, we believe the
research team company will generate revenue of $2.9 billion and pro forma EPS of $2.22. For 2005, we
believe revenue will grow 50% to $4.3 billion and pro forma EPS will reach $2.74.
Heath P. Terry, CFA
212 538 0594
heath.terry@csfb.com
There is no shortage of risks to owning Google. The company has a short operating
history, plans to give little detail or guidance on its business, and is facing increasing
Andrew Thomas competition in a rapidly changing industry. However, we believe that the companys
212 538 0868
andrew.thomas@csfb.com superior growth profile, strong market position, and attractive valuation relative to that
growth rate tip the risk/reward decidedly in the favor of long-term GOOG investors.

FOR IMPORTANT DISCLOSURE INFORMATION relating to analyst certification, the Firms rating system, valuation
methods and potential conflicts of interest regarding companies that are the subject of this report, please refer to the
Disclosure Appendix. U.S. Regulatory Disclosure: CSFB does and seeks to do business with companies covered in its
research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Customers of CSFB in the United States can receive independent, third party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent
research at www.csfb.com/ir or call 1 877 291 2683 or email equity.research@csfb.com to request a copy of this research.
Google, Inc. 28 September 2004

Google, Inc. GOOG OUTPERFORM* [V]

Price (28 Sep 04) 126.86 (US$) 5.0 35.0


52 week high - low 126.86 - 100.01 30.0
4.0
25.0
Target price (12 months) 145.00 (US$)
3.0 20.0
Analyst's Coverage Universe Consumer Internet
2.0 15.0
Weighting (vs. broad market) OVERWEIGHT 10.0
* Stock ratings are relative to the coverage universe in each analyst's or each 1.0
5.0
team's respective sector.
0.0 0.0
31 Dec 03 31 Dec 04 31 Dec 05
Year 12/03A 12/04E 12/05E BVPS P/BVPS
EPS (CSFB adj., US$) 1.31 2.22 2.74
P/E (x) 97.2 57.1 46.4 Year 12/03A 12/04E 12/05E
P/E rel. (%) 483.2 338.2 302.4 Q1 EPS 0.25 0.53 0.59
Revenues (US$m) 1,465.9 2,894.1 4,332.7 Q2 0.26 0.58 0.61
OCFPS (US$) 1.54 2.02 3.70 Q3 0.36 0.54 0.73
P/OCF (x) 82.3 62.9 34.3 Q4 0.42 0.57 0.80
P/BV (x) 33.2
ROIC / WACC
ROE
Price / Indexed S&P 500
Number of shares (m) 265.22 Price/Sales (x) 11.6 Daily Aug 19, 2004 - Sep 28, 2004, 8/19/04 = US$100.34
125
BV/Share (Current, US$) 3.82 Dividend (12/03A, US$m)
120
Dividend yield
115
Historical valuation 110
Year 12/02A 12/03A 12/04E 105
Y/E closing price (US$) 126.86 100
Market cap. (US$m) 33,645.81 Aug-04
Price Indexed S&P 500
Book value/share - hist. (US$) 3.82

Key historical ratios REV / IC Op. Margin


P/BV - hist. (x)
100%
P/E at closing price (x) 57.1
80%
Company description 60%
The company is the leading Internet search destination worldwide.
40%
20%
0%
Dec-03 Dec-04 Dec-05
ROE

Source: Company data, CREDIT SUISSE FIRST BOSTON (CSFB) estimates


On 09/28/04 the S&P 500 index closed at 1,110.06

2
Google, Inc. 28 September 2004

Investment Summary
We initiated coverage on Google with an Outperform rating and a 12-month price target
of $145. In its relatively short operating history, Google has grown into the fourth most
visited site on the Internet and the dominant search engine with more than 50% share.
We believe that Google is well positioned to take advantage of the dramatic growth in
the Internet in general and online advertising specifically. Given the leverage in the
companys model, we believe that Google will be able to translate this into significant
free cash flow growth.
We believe that the dramatic shift in consumers media consumption habits will force
advertisers to shift spending online at a faster-than-expected rate. With consumers
already spending 32% of their media time online for either personal or works reasons
according to Forresters 2003 Benchmark Study, there is a significant gap between the
amount of resources (money) advertisers are devoting to online and the amount of time
customers (whom advertisers are trying to reach) spend online.

Based on our forecasts, we believe that the online advertising market will grow by
19.8% annually to $17.9 billion in 2008. Given that this will still represent less than 9%
of the total U.S. ad market, we believe these estimates may still prove to be
conservative as advertisers seek to close the gap with their consumers. While the lines
between types of online advertising are becoming increasingly blurred, we believe that
search-based advertising will drive much of this growth. We expect that search-based
advertising will grow by 26.4% annually to reach $8.4 billion by 2008. We believe much
of this growth will come from capturing local advertising dollars that are currently going
to the $16 billion Yellow Pages industry.

Acknowledging the difficulty in forecasting the growth of a company as young as Google


in such a rapidly changing industry, we expect Google will be able to continue to grow
revenue by roughly 50% annually over the next five years and earnings by over 30%.
The lower earnings growth rate is the result of Googles plan to increase the investment
level of its business and the dilution caused by the companys stock option program. For
2004, we believe the company will generate revenue of $2.9 billion and pro forma EPS
of $2.22. In 2005, we believe revenue will grow 50% to $4.3 billion and pro forma EPS
will reach $2.74.

Valuation is likely to be the most difficult issue for investors in GOOG for a variety of
reasons, including the lack of transparency, the dual-class structure, and what is
expected to be an unusually wide range of analyst estimates. In our valuation analysis,
we have arrived at prices ranging from $82 all the way to $220, each with its own
justification. We have triangulated to an initial 12-month target price of $145 based
primarily on our own discounted cash flow (DCF) model.

There is no shortage of risks to owning Google. The company has a short operating
history, plans to give little detail or guidance on its business, and is facing increasing
competition in a rapidly changing industry. However, we believe that the companys
superior growth profile, strong competitive position, and attractive valuation relative to
that growth rate tip the risk/reward decidedly in the favor of long-term GOOG investors.

3
Google, Inc. 28 September 2004

Industry Overview

Global Internet Outlook


Globally, the Internet continues to grow at astounding rates as improvements in access,
services, and content drive more users to spend more time and money online. Total
industry spend in 2003 of $103 billion is expected to increase to $224 billion by 2008, a
16.8% compounded annual growth rate, according to PricewaterhouseCoopers. As the
cost of broadband access continues to decline and Internet service becomes more
available globally, total Internet usage will continue to grow. As shown in Exhibit 1,
online advertising and access spending are predicted to increase in all markets through
2008, with the Asia-Pacific region achieving the highest growth rate and becoming that
largest market in the world.

Exhibit 1: Online Advertising and Internet Access Spending


US$ in millions, unless otherwise stated

$250,000

$200,000

$150,000

$100,000

$50,000

$0
E

E
99

00

01

02

03

04

05

06

07

08
19

20

20

20

20

20

20

20

20

20
United States EMEA Asia/Pacific Latin America Canada

Source: PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

U.S. Internet Trends


Because of the relative maturity of the market, growth in the United States will be
markedly slower. The U.S. online advertising and Internet access market is expected to
grow 7.8% compounded annually to $44.2 billion by 2008. Again, the principal growth
driver is broadband, which is expected to grow from $12.6 billion in 2003 to $25.9 billion
in 2008. As new subscribers become attracted to lower priced dial-up services, as
shown in Exhibit 3, the total Internet universe will increase. However, it is important to
note that there will be a larger shift of subscribers from dial-up to broadband, resulting in
a net decrease in dial-up revenues. Dial-up is expected to decline 8.1% compounded
annually from $10.5 billion in spend for 2003 to $6.9 billion in 2008. And as more people
make the switch to Broadband, that industry is predicted to grow from $12.6 billion in
2003 to $25.9 billion in 2008, which is illustrated in Exhibit 2.

4
Google, Inc. 28 September 2004

Exhibit 2: Online Advertising and Internet Access Spending Market


US$ in millions, unless otherwise stated
04 - '08
United States 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E CAGR
Access Spending 8,305 11,858 16,953 19,866 23,112 25,494 27,784 29,634 3,138 32,832
% Change 39.8 42.8 43.0 17.2 16.3 10.3 9.0 6.7 5.8 4.8 7.3
Dial - Up 7,382 8,813 10,305 10,643 10,541 9,834 9,208 8,466 7,722 6,912
% Change 30.9 19.4 16.9 3.3 (1.0) (6.7) (6.4) (8.1) (8.8) (10.5) (8.1)
Avg. Monthly Spend 18.20 18.00 18.35 18.25 18.00 17.70 17.40 17.00 16.50 16.00
Broadband 923 3,045 6,648 9,223 12,571 15,660 18,576 21,168 23,616 25,920
% Change 206.6 229.9 118.3 38.7 36.3 24.6 18.6 14.0 11.6 9.8 15.6
Avg. Monthly Spend 45.25 49.75 55.40 50.90 48.50 45.00 43.00 42.00 41.00 40.00
Online Advertising 4,621 8,225 7,210 6,010 7,240 8,300 9,200 10,000 10,700 11,400
% Change 140.7 78.0 (12.3) (16.6) 20.5 14.6 10.8 8.7 7.0 6.5 9.5
Total 12,926 20,083 24,163 25,876 30,352 33,794 36,784 79,634 42,038 44,232
% Change 64.5 55.5 20.3 7.1 17.3 11.3 9.4 7.2 6.1 5.2 7.8

Source: FCC, Interactive Advertising Bureau, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

The growth in the Internet over the past decade has been ground breaking. However,
future growth from the earliest and strongest driver, new users, will be limited with
household penetration rates already above 60%. Currently, the total U.S. Internet
universe is 70.4 million households, or 63.9% of all U.S. households, and it is projected
to increase to 90.0 million subscribers, or 77.3%, by 2008. Broadband, which currently
has 31% of all Internet subscribers, is expected to surpass dial-up by 2006, to capture
60% of all U.S. subscribers. This is critical to future growth as broadband users currently
spend nearly twice as much time online as narrowband users. Exhibit 3 details the
number of households that are currently a part of the active Internet universe and their
predicted growth through 2008.

Exhibit 3: U.S. Active Internet Universe


US$ in millions, unless otherwise stated

90

80

70

60

50

40

30

20

10

0
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Dial -Up Broadband

Source: eMarketer, FCC, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

Illustrated in Exhibit 4 are household penetration figures.

5
Google, Inc. 28 September 2004

Exhibit 4: U.S. Household Penetration


US$ in millions, unless otherwise stated

120
110
100
90
80
70
60
50
40
30
20
10
0
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

U.S. Households U.S. Households Penetrated

Source: eMarketer, FCC, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

U.S. Advertising Market


According to PricewaterhouseCoopers, the overall advertising market grew 4.8% from
2002 to reach $156 billion in 2003 and is predicted to continue growing on this upward
trend to achieve a 5.4% compound annual growth rate (CAGR) to grow to $206 billion
by 2008. As illustrated in Exhibit 5, television advertising makes up the largest part of
the market at 39% in 2003, with newspapers following with 28% of market share. Total
Internet advertising spend was 5% of total advertising in 2003. PWC predicts that there
will be little change in market share over the next five years as illustrated in Exhibit 6.
Internet advertising is expected to be the fastest-growing segment, averaging about a
9.5% CAGR.

Exhibit 5: U.S. 2003 Advertising Spend Exhibit 6: U.S. 2008 Advertising Spend

TV Networks Newspapers TV Networks


Newspapers 20% 21%
28% 26%

TV Distribution Magazines TV Distribution


Magazines 19% 12% 19%
12% Internet Radio Internet Radio
5% 12% 6% 12%
Out-of-Home
4% Out-of-Home
4%

Source: PricewaterhouseCoopers LLP, Wilkofsky Source: PricewaterhouseCoopers LLP, Wilkofsky


Gruen Associates. Gruen Associates.

Exhibit 7 details PwCs expectations for ad spending by channel.

6
Google, Inc. 28 September 2004

Exhibit 7: U.S. Advertising Spend by Channel


US$ in millions, unless otherwise stated
04 - '08
United States 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E CAGR
TV Networks 23,963 28,417 26,962 28,046 30,723 34,460 36,370 39,100 40,850 44,220
% Change 9.9 18.6 (5.1) 4.0 9.5 12.2 5.5 7.0 4.5 8.5 7.6
TV Distribution 36,345 39,496 25,438 28,260 29,093 32,550 32,900 35,600 36,350 39,300
% Change 3.2 12.0 (13.8) 11.1 2.9 11.9 1.1 8.2 2.1 8.1 6.2
Radio 17,215 19,295 17,861 18,877 19,493 20,680 21,690 23,100 24,210 25,670
% Change 14.2 12.1 (7.4) 5.7 3.3 6.1 4.9 6.5 4.8 6.0 5.7
Out-of-Home 4,832 5,235 5,193 5,232 5,505 5,850 6,250 6,640 7,040 7,440
% Change 9.5 8.3 (0.8) 0.8 5.2 6.3 6.8 6.2 6.0 5.7 6.8
Internet 4,621 8,225 7,210 6,010 7,240 8,300 9,200 10,000 10,700 11,400
% Change 140.0 78.0 (12.3) (16.6) 20.5 14.6 10.8 8.7 7.0 6.5 9.5
Magazines 21,346 23,260 19,493 18,222 18,967 19,860 21,000 22,400 23,800 25,100
% Change 5.0 9.0 (16.2) (6.5) 4.1 4.7 5.7 6.7 6.3 5.5 5.8
Newpapers 46,289 48,671 44,304 44,102 44,939 46,150 47,650 49,160 51,000 53,150
% Change 5.4 5.1 (9.0) (0.5) 1.9 2.7 3.3 3.2 3.7 4.2 3.4
Total 144,611 162,599 146,461 148,749 155,960 167,850 175,060 186,000 193,950 206,280
% Change 8.7 12.4 -9.9 1.6 4.8 7.6 4.3 6.2 4.3 6.4 5.8

Source: PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

U.S. Online Advertising Market


We are significantly more optimistic about the prospects for growth in online advertising
in the United States. We believe that the dramatic shift in consumers media
consumption habits will force advertisers to shift spending online at a faster-than-
expected rate. With consumers already spending 32% of their media time online for
either personal or works reasons, according to Forresters 2003 Benchmark Study,
there is a significant gap between the amount of resources (money) advertisers are
devoting to online and the amount of time customers (whom advertisers are trying to
reach) are spending online. Given that younger consumers are spending even more
time of their time online, as much as 50% in some studies, we believe advertisers
motivation to find ways to reach consumers online is only going to grow.

7
Google, Inc. 28 September 2004

Exhibit 8: U.S. Online Ad Spend Estimates


US$ in millions, unless otherwise stated

$20,000

$18,000

$16,000

$14,000

$12,000

$10,000

$8,000

$6,000

$4,000

$2,000

$0
2001A 2002A 2003A 2004E 2005E 2006E 2007E 2008E

Impression Advertising Paid Search Email Rich Media

Source: Internet Advertising Bureau, CSFB estimates.

Based on our forecasts, we believe that the online advertising market will grow by
19.8% annually to $17.9 billion in 2008. Given that this will still represent less than 9%
of the total U.S. ad market, we believe these estimates may still prove to be
conservative as advertisers seek to close the gap with their consumers. While the lines
between types of online advertising are increasingly being blurred, we believe that
search-based advertising will drive much of this growth. We expect that search-based
advertising will grow by 26.4% annually to reach $8.4 billion by 2008. In our view, much
of this growth will come from capturing local advertising dollars that are currently going
to the $16 billion Yellow Pages industry.

Looking back, the U.S. online advertising markets began to grow steadily beginning in
the fourth quarter of 2002, following the dramatic decline of the bubble bursting years of
2001 and 2002. Advertising continued to rise after that, and in the fourth quarter of
2003, it surged 38% reaching $2.2 billion. That growth accelerated in the first quarter of
2004, the most recent with official data, to 39%, or $2.3 billion in online spending.

The key driver in this jump was the increase in paid-search advertising, which more than
doubled to $2.1 billion in 2003. Paid-Search advertising is text advertising presented in
order to appeal to search users based on their typed search queries. Advertisers are
particularly attracted to paid-search advertising because they capture consumers when
they are looking for information and pay only when the user clicks on the ad. This
combines for a high and easily measurable return on investment.

8
Google, Inc. 28 September 2004

Exhibit 9: U.S. Paid Search Spending


US$ in billions, unless otherwise stated

$6.0

$5.5

$5.0 $5.0

$4.4
$4.0
$3.8

$3.2
$3.0
$2.6

$2.0 $1.9

$1.0

$-
2003 2004 2005 2006 2007 2008 2009

US Paid Search Spending

Source: JupiterResearch Internet Advertising Model, 07/04.

Another growing segment in the online advertising industry is rich media advertising,
which jumped from $200 million in 2002 to $600 million in 2003 as advertisers took
advantage of the growth in broadband connections. Rich media is a broad term covering
any type of ad with sound, motion, or video. In addition to providing a more compelling
consumer experience and conveying a more in-depth message, rich media ads have
significantly higher click-through rates.

The growth of online retail sales has also been a significant factor in the growth of online
advertising as advertisers seek to convert users online into immediate sales. Online
sales in the United States doubled from the $28 billion spent in 2000 to $56 billion in
2003. We believe that online retail will continue to grow by roughly 14% annually to
reach $108 billion in 2008. Advertisers recognize this growth and will spend more of
their advertising dollars to reach this customer base, contributing to the expected growth
in online advertising.

International Online Advertising and Access Spending


The growth in online advertising certainly isnt limited to the U.S. Internet advertising,
and access spend in the Asia-Pacific region is expected to more than triple over the
next five years, reaching $99.1 billion in 2008 from $30.6 billion in 2003, a 26.5%
compound annual growth increase, according to PricewaterhouseCoopers. Accounting
for 90% of the expected growth comes from four countries, China with expected 2008
spend of $63.6 billion, Japan at $13.6 billion, South Korea with $7.0 billion in spend, and
India coming in at $4.6 billion in 2008. The Europe, Middle East, and Africa (EMEA)
market is expected to double in size from $38.6 billion in 2003 to $72.2 billion by 2008.
Western Europe contributes 88% of total spend in 2003 and will continue to dominant
the region; however, the fastest growing area will be in the Middle East/Africa region,

9
Google, Inc. 28 September 2004

though it will still represent only $2.8 billion by 2008. Latin America is expected to triple
the amount of dollars spent in online advertising and access spending from $2.1 billion
in 2003 to $6.2 billion in 2008. Lastly, Canada is also expected to grow its online ad and
access spend to $2.2 billion by 2008, a 12.2% CAGR from 2003. Exhibit 10 shows total
international spend by region.

Exhibit 10: International Online Advertising and Access Spend


US$ in millions, unless otherwise stated

$180,000

$160,000

$140,000

$120,000

$100,000

$80,000

$60,000

$40,000

$20,000

$0
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Asia/Pacific EMEA Latin America Canada

Source: FCC, Interactive Advertising Bureau, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

Specifically, online advertising outside the United States is expected to grow at a rate of
13.2% annually over the next five years. In 2008, the total online advertising market will
be $7.5 billion, or 3.7% of the total non-U.S. advertising market, up from $3.2 billion and
2.0% in 2003. Exhibit 13 details the amount expected to be spent on online advertising
by country. The Asia-Pacific and EMEA regions accounted for 95% of total Internet
advertising spend internationally in 2003, with Asia-Pacific at 43% and EMEA at 51%.
Over the next five years Asia-Pacific is expected to grow 15.1% annually, while the
EMEA region is expected to grow 9.9 annually.

10
Google, Inc. 28 September 2004

Exhibit 11: International Online Advertising Spend


US$ in millions, unless otherwise stated

$8,000

$7,000

$6,000

$5,000

$4,000

$3,000

$2,000

$1,000

$0
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Asia/Pacific EMEA Latin America Canada

Source: FCC, Interactive Advertising Bureau, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

International Internet Universe


Internationally, the number of households connected to the Internet are growing
significantly year over year. Exhibit 12 details the number of users expected to have
Internet connection by 2008. The Asia-Pacific market is expected to grow 136% from
2003 to 2008 to 552 million users. Many of the countries included in the Asia-Pacific
region have initiated long-term infrastructure initiatives, and these programs are the key
drivers in increasing the Internet universe. Historically, within the EMEA, growth in the
Internet universe was hindered by high telephone costs; thus making the Internet too
costly for a majority of potential users. However, a number of countries within the region
have made their telephone markets open to competition, which has brought down the
cost to connect online. The EMEA is expected to grow from 236 million users in 2003 to
363 million users by 2008, a 54% increase. Canada and Latin America are much
smaller markets than the Asia-Pacific and EMEA regions but are both expected to grow.
Latin America is expected to increase its active Internet universe to 89.8 million users by
2008, a 152% increase over 2003, and Canada is expected to grow its Internet universe
by 3.5 million users to 11.1 million users by 2008.

11
Google, Inc. 28 September 2004

Exhibit 12: International Active Internet Universe


US$ in millions, unless otherwise stated

1,200

1,000

800

600

400

200

-
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Asia/Pacific EMEA Latin America Canada

Source: FCC, Interactive Advertising Bureau, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

Overall penetration for all international regions is expected to increase through 2008.
The EMEA is expected to increase its penetration rate by 138%, the largest growth in
the world, to 47.6% by 2008. Although the Asia-Pacific countries are expected to
increase the number of users online, they still will have significant upside potential,
especially in areas such as the Peoples Republic of China and India, which are
expected to grow by 233 million users but will only achieve a 19.2% and 6.2%
penetration rate. Exhibit 13 displays penetration percentages by international region.
Canada is very similar to the United States; with its penetration rate at 61.3% for 2003, it
will understandably be limited in its growth. By 2008, Canada is expected to achieve an
83% household penetration rate, making it the highest penetrated international market
by far.

12
Google, Inc. 28 September 2004

Exhibit 13: International Household Penetration

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0%
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Asia/Pacific EMEA Latin America Canada

Source: FCC, Interactive Advertising Bureau, PricewaterhouseCoopers LLP, Wilkofsky Gruen Associates.

13
Google, Inc. 28 September 2004

Online Search Industry


Much of the comparison and market share work that we do is based on data provided
by Nielsen-NetRatings and ComScore Media Metrix. While these data are the best
available, they are survey data based on a limited audience with all of the limitations
that implies. It is also limited to the United States, as an international equivalent data
standard doesn't yet exist. Investors should keep both things in mind when making
conclusions based on these survey data.

The Internet continues to increase its popularity as a key source of information for
users. Since August 2001, the number of pages viewed by online users in the United
States has increased 40% from 36 billion pages to 51 billion. As the active Internet
universe continues to grow, this number is expected to rise. Exhibit 14 illustrates the
continued growth in pages viewed by online users.

Exhibit 14: Total Page Views

60,000,000,000

55,000,000,000

50,000,000,000

45,000,000,000

40,000,000,000

35,000,000,000

30,000,000,000
O 1

Fe 1

Ap 2

Ju 2

Au 2

O 2

Fe 2
03

Ju 3

Au 3

O 3

Fe 3

Ap 4

Ju 4

Au 4
04
D 1

D 2

D 3
0

-0

r-0

-0

r-0

-0

r-0

0
-0

-0

-0

0
g-

b-

n-

g-

b-

n-

g-

b-

n-

g-
ec

ec

ec
ct

ct

ct
Ap
Au

Total Page Views

Source: Nielsen-NetRatings, CSFB estimates.

As search engines continue to improve their technologies, a greater number of online


users will use the Internet to find information they are seeking. According to a survey
conducted by Forrester Research, over 32% of people surveyed said they use the
Internet as their primary method of looking for information. Exhibit 15 demonstrates the
rising trend of online users who use search capabilities while on the Internet.

14
Google, Inc. 28 September 2004

Exhibit 15: Total Search Users

250,000,000
240,000,000
230,000,000

220,000,000
210,000,000

200,000,000
190,000,000
180,000,000

170,000,000
160,000,000
150,000,000

4
02

02

03

03

04

4
2

4
-0

-0

-0

-0

-0
-0

-0

-0
l-0

l-0

l-0
n-

p-

n-

p-

n-
ay

ov

ay

ov

ay
ar

ar

ar
Ju

Ju
Ju
Ja

Ja

Ja
Se

Se
M

M
M

M
N

N
Total Search Users

Source: Nielsen-NetRatings, CSFB estimates.

As exhibited above, search has become an increasingly popular online activity. August
2004 data reveal that search users actually constitute a majority of total online users, at
51.6% of total users.

Exhibit 16: Total Search and Nonsearch Users

500,000,000

450,000,000

400,000,000

350,000,000

300,000,000

250,000,000

200,000,000

150,000,000

100,000,000

50,000,000

-
2

4
02

02

03

03

04

4
2

4
-0

-0

-0

-0

-0
-0

-0

-0
l-0

l-0

l-0
n-

p-

n-

p-

n-
ay

ay
ov

ay
ov
ar

ar

ar
Ju

Ju

Ju
Ja

Se

Ja

Se

Ja
M

M
M

M
N

Total Search Users Total non-Search Users

Source: Nielsen-NetRatings, CSFB estimates.

15
Google, Inc. 28 September 2004

Dominating the search market is Google, Inc., which captured 26.3% of total search
users in August 2004. Rounding off the top five players in the search industry are Yahoo
Inc. (YHOO, $31.82, Outperform, target $45.00, Overweight), Microsoft Corporations
MSN (MSFT, $27.19, Neutral, target $27.00, Overweight), Time Warners AOL (TWX,
$16.33, Outperform, target $23.00, Overweight), and Ask Jeeves, Inc. (ASKJ, $31.69,
Neutral, target $33, Overweight). However, Google and Ask Jeeves are the only top five
search engines that have experienced growth in market share since January 2002; the
others have declined. Google has increased its share of the online search industry by
94% since January 2002 and has taken away market share from the top players as well
as other smaller search engines, as is evident in Exhibit 17 and Exhibit 18. Ask Jeeves
has tripled its market share owing to its acquisition of ISH. Among the top five, AOL has
experienced the largest drop in search users, declining 56% and capturing 8.7% of total
search in August 2004.

Exhibit 17: Share of Search Users January, Exhibit 18: Share of Search Users August,
2002 2004

Others Google Others


14% 13% Google
18%
Ask Jeeves 26%
Ask Jeeves
9%
3%

Yahoo AOL
AOL 25% 9%
20%
MSN Yahoo
MSN 24%
20% 19%

Google Yahoo MSN AOL Ask Jeeves Others Google Yahoo MSN AOL Ask Jeeves Others

Source: Nielsen-NetRatings. Source: Nielsen-NetRatings.

Similar to the trend observed with search users in the market, the share of page views is
dominated by Google, which has slightly over half the share of search page views. The
other top players in the search industry have a significantly smaller share of search
page views, with Yahoo in second place at 23.8%.

Exhibit 19: Share of Search Page Views Exhibit 20: Share of Page Views August,
August, 2001 2004

Ask Jeeves
4%
Others Others
Ask Jeeves AOL
7% 5%
3% Google 5%
AOL 28% MSN
17% 10%

Google
52%
MSN Yahoo
19% Yahoo 24%
26%

Google Yahoo MSN AOL Ask Jeeves Others Google Yahoo MSN AOL Ask Jeeves Others

Source: Nielsen-NetRatings. Source: Nielsen-NetRatings.

16
Google, Inc. 28 September 2004

Company Overview
Larry Page and Sergey Brin met at Stanford University in 1995 and later founded
Google, which was incorporated in 1998. The company is the leading Internet search
destination worldwide, with the mission to organize the worlds information and make it
universally accessible and useful. Google monetizes the ability to connect people with
information by serving advertisements that are relevant to users keyword searches. The
company organizes information through multiple channels besides search, including
news, shopping (Froogle), groups, catalogs, and e-mail, but the companys search
technology underlies everything.

The Basics
WebSearch
Currently, Google WebSearch provides access to approximately 4.3 billion Web pages.
The Web site features 11 distinct functions: advanced search functionality, spell
checker, Web page translation, stock quotes, street maps, calculator, definitions, phone
book, search by number, travel information, and cached links.

Exhibit 21: Google WebSearch Results Page

Source: www.google.com.

17
Google, Inc. 28 September 2004

Image Search
Googles Image Search is an index of over 880 million images. The service allows users
the ability to search for images based on size, format, and coloration, as well as a filter
technology for adult content.

Exhibit 22: Image Search Results Page

Source: www.google.com/images.

News
The company aggregates information from approximately 10,000 sources worldwide
into a product for 10 different international audiences. Users can set up e-mail alerts
based on keywords in order to be notified whenever news of interest hits. Google News
is still in beta, as are many of the services offered on the site.

18
Google, Inc. 28 September 2004

Exhibit 23: Google News

Source: www.google.com/news.

Froogle
Froogle is the companys shopping search engine. Froogle combines information about
products and destinations to purchase. Googles technology allows users to search for
products by price, as well as view product photos. The companys technology displays
current product information from retailer Web sites. Froogle is still in beta testing.

19
Google, Inc. 28 September 2004

Exhibit 24: Froogle Results Page

Source: froogle.google.com.

Google Groups
Google Groups allows information consolidation of discussion group information and
posts through tools allowing searching, reading, and browsing. The company has
discussion group archives from Usenet dating back to 1981, with over 845 million
posted messages to search from. The company currently has in beta testing a new
version of Google Groups, which enhances the user interface, allows for new group
creation, and offers faster posting.

20
Google, Inc. 28 September 2004

Exhibit 25: Google Groups Results Page

Source: /www.google.com/groups.

Google Catalogs
Google Catalogs compiles over 6,600 mail order catalogs.

Exhibit 26: Google Catalogs Homepage

Source: www.google.com/catalogs.

21
Google, Inc. 28 September 2004

Google Local
With the local Yellow Pages capturing $16 billion in advertising spending, Local is a
major priority for Google. Their Google Local offering, still in beta, provides local search
technology, by combining current search technology with local business listings,
addresses, phone numbers, maps, directions, and zip codes.

Exhibit 27: Google Local Results

Source: local.google.com.

Google Toolbar
The company provides a downloadable toolbar that combines Googles search
technology with features such as pop-up blocking, PageRank Indicator, AutoFill,
Highlight, and Word Find.

22
Google, Inc. 28 September 2004

Exhibit 28: Google Toolbar

Source: toolbar.google.com.

Google Wireless
This feature enables users to search Googles 4.2 billion indexed pages and view
results to about 5 million pages created specifically for wireless devices. Google
Wireless works on devices that support WAP, WAP 2.0, I-mode, or j-sky mobile Internet
protocols.

23
Google, Inc. 28 September 2004

Exhibit 29: Google Wireless

Source: www.google.com/options/wireless.

Google Alerts
With Google Alerts, users may set specialized search criteria to receive updates on a
specific topic directly to their e-mail. The search parameters that are included are
Search Terms, Type (News, Web), and How Often (once a day, once a week, as it
happens).

Exhibit 30: Google Alerts

Source: www.google.com/alerts.

24
Google, Inc. 28 September 2004

Google Search Appliance


Google began offering the Google Search Appliance (GSA) in February of 2002. The
GSA offers Googles search technology in a complete hardware and software solution
for enterprises. The company is targeting the largest companies in the world as well as
governments with the intranet solution. The company generally employs two-year term
licenses priced between $32,000 and $525,000, depending on the size and scope of the
enterprises. The company currently has deals in place in North America only. The GSA
can usually be installed and launched within a day and has three models: the GB-1001,
GB-5005, and GB-8008 that vary based on search capacity.

Future Products/Services
Google is still very much an early-stage growth company. While search is essentially at
the core of everything the company does, the company has a host of services in various
stages of development designed to leverage the companys superior search technology
and advertising network. Googles much-talked-about policy of allowing their engineers
20% of their time to work on new ideas results in a lot of creative communication within
the company. Google is very open with these development services through the Google
Labs portion of the site.

Google Labs is the companys display of creative thinking, in which engineers and
Google users present new test ideas and products. It is also a forum for feedback on
current Google products and services for improvements and optimizations. Examples of
the companys current Google Labs projects include: Personalized Web Search, Google
Deskbar, Voice Search, and Froogle Wireless.

25
Google, Inc. 28 September 2004

Exhibit 31: Google Labs

Source: labs.google.com.

Gmail
Gmail is Googles free e-mail service that gives users 1 gigabyte of storage, allowing
them to keep and search all e-mails. Gmail also uses the companys advertising
technology to scan the content of e-mails and displays content-related advertising on
the side of the page. The service is still in beta testing and is currently available by
invitation only.

26
Google, Inc. 28 September 2004

Exhibit 32: Gmail Login

Source: gmail.google.com.

Orkut
Orkut is an online community that connects people through a linked network. Currently,
it is available by invitation only and gives members the ability to interact with different
people based on commonalities such as mutual friends or similar interests.

Exhibit 33: Orkut Homepage

Source: www.orkut.com.

Blogger
Blogger is a Web-based publishing tool that allows users the ability to publish
chronologically arranged information. The Web site allows users to aggregate
communications in a Web page fashion that is easier to follow than traditional e-mail or

27
Google, Inc. 28 September 2004

discussion forums. Google acquired Pyra Labs, Bloggers developer, in Febuary of


2003.

Exhibit 34: Blogger

Source: www.blogger.com/start.

Picasa
Picasa is a digital photo management service recently acquired by Google. Users are
able to manage, share, and make minor edits to their pictures.

28
Google, Inc. 28 September 2004

Exhibit 35: Picasa Homepage

Source: www.picasa.com/picasa.

Business Model
Google generates revenue by placing advertisements on Google.com and Google
Network Web sites. The company currently has well over 150,000 advertising partners,
most of which have had a relationship with the company for over 18 months. The
average advertiser is small to medium sized, and examples of recent top advertisers
include Vacations To Go, Swanksoft, Lumber Liquidators, and Get Me Tickets.
However, as the search industry matures, larger advertisers are becoming more and
more common.

AdWords
AdWords is the basis of Googles global advertising program. When a user types in a
particular keyword into the search query, the companys search technology provides a
listing of search results most relevant to the query in the middle of the page. In
highlighted fields above those results and on the right hand side of the Web page,
Google delivers text advertisements based on a combination of relevance and
advertisers bids for the keyword. This is different from the Yahoo Overture system that
relies on the advertisers bid only. While Yahoo likely gets a higher price per click
because of this, Googles inclusion of relevance in determining placement likely results
in a higher click-through rate.

The cost-per-click model is very straightforward: Google is paid each time a user clicks
on an advertisement. Keyword costs range from $0.05 to several dollars in the case of

29
Google, Inc. 28 September 2004

high value words like insurance, mortgage, and attorney. Most advertisers set up and
fund their accounts online, though Google does have a direct salesforce for larger
advertisers.

Google Network/AdSense
The Google AdSense program is the companys program that serves targeted ads from
the AdWords program to Google Network Web sites. The program targets
advertisements by either search results or Web content. The company shares the
majority (estimated to be around 80%) of the revenues generated by the advertisements
with the Network Web sites. Most of the Web sites that make up the Google Network
sign up online and have no required term. For the large search audience Web sites,
Google offers AdSense for search, which utilizes Google WebSearch technology to
serve advertisements from the AdWords program on the Network Web site. Major
network Web sites that use AdSense for search include AOL, Ask Jeeves, and Earthlink
Inc. (ELNK, $10.00, Neutral, target $12.00, Overweight).
Google AdSense for content allows Network Web sites to serve targeted
advertisements from the Google AdWords program based on the content of the page.
Google does not charge Network Web sites for use of AdSense for content, and shares
the majority of revenues generated from the click-throughs, similar to AdSense for
search. Google also provides customization services for Web sites that generate more
than 20 million page views per month. Network Web sites that use AdSense for content
include New York Times Co. (NYT, $38.72, Neutral, target $50.00, Overweight), Forbes,
ABC, and About.com.

Acquisition History

Exhibit 36: Acquisition History


Company Date Reason/Purpose
Deja Feb-01 Database for google groups
Groupfire/Outride Jun-01 Personalization
Pypa/Blogger Feb-03 IM Users
Applied Semantics Apr-03 Content targeted ads
Neotonic Apr-03 Adwords customer service and google groups
Kaltix Sep-03 Personalization of search
Sprinks Oct-03 Targeted ad program
IgniteLogic Apr-04 Web Hosting (gmail type expertise)
Source: Company data, CSFB estimates.

Google Technology
Google divides technology into three buckets: Web search, advertising, and large-scale
systems.

Web Search Technology


The companys Web search technology is the techniques and algorithms that match the
users search query with the resulting relevant page of links. There are two main
technologic thrusts underlying the overall search process, a ranking technology and a
text-matching technology. The ranking technology, PageRank, named after Larry Page,
is the companys primary technology. The technology is built on ranking the link

30
Google, Inc. 28 September 2004

structure of the Web. The text-matching techniques compare search queries with Web
page content to determine relevance. The combination of the two techniques allow for
the most relevant search results. Google is constantly tweaking its search technology to
improve functionality and deter search spammers that attempt to game the system for
higher placement.

Advertising Technology
The companys Advertising technology works to maximize revenue by combining
relevance and price per click. The Google AdWords real-time auction system delivers
targeted advertisements to the winner of the individual auction for that key word search.
The auction process is determined by an advertisers willingness to pay for prominence
in the ad listing (the CPC) and interest from users in the ad as measured by the click-
through rate and other factors. Therefore if an advertisement does not achieve clicks,
the automated technology of the auction system will move the advertisement to a less
prominent position, even if the advertiser offers a greater amount. This practice
discourages advertisers attempting to gain exposure through certain irrelevant
keywords. The auction technology also employs the AdWords discounter, which lowers
the amount of the bid to the minimum needed to maintain the position prominence.
The second piece of the Advertising technology is called AdSense Contextual
Advertising Technology, which utilizes keyword analysis, word frequency, font size, and
the link structure of the Web (like PageRank) to analyze Web page content to match
relevant advertisements. This technology is also used for other forms of textual content,
including Gmail and Google Groups postings.

Large-Scale Systems Technology


Large-Scale Systems Technology refers to Googles use of infrastructure to achieve
scale returns of computing resources at low cost. The technology allows the company to
process and store large amounts of data and enables improvements in search and
advertising results through intense algorithmic computations.

Google versus Competitors


Unique Search Users
As illustrated in Exhibit 21, Googles search audience has increased 133% since
January 2002 to reach 54.7 million search users in July 2004. Google first surpassed
Yahoo in November 2003 by 1 million users and has maintained the lead ever since.

31
Google, Inc. 28 September 2004

Exhibit 37: Unique Search Audience

70,000,000

60,000,000

50,000,000

40,000,000

30,000,000

20,000,000

10,000,000

Ju 2

Ju 3

Ju 4
Fe 02
M 02

Ap 2

Ju 2

Se 02

O 2

D 02

Ja 2
Fe 03
M 03

Ap 3

Ju 3

Se 03

O 3

D 03

Ja 3
Fe 04
M 04

Ap 4

Ju 4
M 2

Au 02

N 02

M 03

Au 03

N 3

M 4

4
-0

-0

-0
-0
r-0

-0

-0

0
-0

-0

-0
r-0

0
l-0
-

-
n-
b-

n-

l-
g-
p-

n-
b-

r-

n-

l-
g-
p-

n-
b-

n-
ay

ov

ay

ov

ay
ar

ar

ar
ec

ec
ct

ct
Ja

Google Yahoo MSN AOL Time Warner Ask Jeeves

Source: comScore MediaMetrix.

Search Page Views


Google also has a significant lead in the number of search page views. The company
has maintained this lead on a continuous basis and the gap between itself and
competitors seems to be growing.

Exhibit 38: Search Page Views

4,500,000,000

4,000,000,000

3,500,000,000

3,000,000,000

2,500,000,000

2,000,000,000

1,500,000,000

1,000,000,000

500,000,000

-
Ju 02

Ju 03

Ju 0 4
Fe 02
M 02
Ap 2

Ju 2

Se 02

O 2

D 02
Ja 2
Fe 03
M 03
Ap 3

Ju 3

Se 03

O 3

D 03
Ja 3
Fe 04
M 04
Ap 4

Ju 4
M 02

Au 02

N 02

M 03

Au 03

N 03

M 4

4
-0

-0

-0

-0

-0
r-0

0
l-0
-

-
n-
b-

r-

n-

l-
g-
p-

n-
b-

r-

n-

l-
g-
p-

n-
b-

n-
ay

ov

ay

ov

ay
ar

ar

ar
ec

ec
ct

ct
Ja

Google Yahoo MSN AOL Time Warner Ask Jeeves

Source: comScore MediaMetrix.

32
Google, Inc. 28 September 2004

Model
First, the disclaimer: Google is still in the very early stages of growth with a business
model that is rapidly evolving in an industry that is constantly changing. The company
has provided no forward guidance, no operating metrics, and little to no transparency
beyond its financial statements. Therefore, any effort to forecast this quarter, much less
the next five years, can only be viewed as a best efforts estimate.

Revenue
Google breaks out revenue into three baskets: Google Web sites, Network Web sites,
and License and Other revenue. The company is expected to grow Network revenue
faster than Google revenue. Exhibit 39 displays the historical breakdown between the
three categories and our expectations. Google Web site revenue relates to sales
generated through advertising listings from Google AdWords. Network Web sites
revenue is generated through listings from Google AdSense program, which serves
advertisements on Google Network member Web sites. Licensing and Other revenue is
generated from sales of the Google Search Appliance and the licensing of Googles
search technology for use on other Web sites.

Exhibit 39: Google Revenue Breakdown


US$ millions

$12,000

$10,000

$8,000

$6,000

$4,000

$2,000

$0
2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Google.com Network License & Other

Source: Company data, CSFB estimates.

We believe that Google can grow revenue by roughly 50% annually from 2003-08. This
growth be driven by the shift of off-line advertising dollars online, an increase in the
number of searches preformed, continued increases in average price per click, greater
keyword coverage, and higher click-through rates.

33
Google, Inc. 28 September 2004

Exhibit 40 details our revenue build work sheet. We build Google Web site revenue as a
product of searches supplied by Nielsen-NetRatings, estimated price per click, and
estimated click-through rates by quarter.

Exhibit 40: Google Revenue Build Work Sheet


US$ in millions, unless otherwise stated
2003 2004 2004 2005 2005
FY Q1 Q2 Q3E Q4E FY Q1E Q2E Q3E Q4E FYE

REVENUE $ 1,465.93 $ 651.62 $ 700.21 $ 735.02 $ 807.29 $ 2,894.15 $ 946.84 $ 986.02 $ 1,062.35 $ 1,337.54 $ 4,333
Q/Q Growth 27% 7% 13% 15% 17% 4% 8% 26%
Y/Y Growth 234% 162% 125% 87% 58% 97% 45% 41% 45% 66% 50%
Cost of Revenue 625.85 315.40 326.38 343.21 381.98 1,366.97 460.99 472.97 509.45 671.02 2,114.43

Google Revenue $ 792.06 $ 303.53 $ 343.44 $ 356.99 $ 381.79 $ 1,385.75 $ 448.82 $ 469.15 $ 510.00 $ 597.93 $ 2,026
Q/Q Growth 24% 13% 18% 11% 18% 5% 9% 17%
Y/Y Growth 158% 98% 88% 69% 57% 75% 48% 37% 43% 57% 46%
Cost of Revenue 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0%

Network Revenue $ 628.60 $ 333.75 $ 346.23 $ 364.02 $ 409.46 $ 1,453.46 $ 478.83 $ 496.67 $ 530.05 $ 714.31 $ 2,220
Q/Q Growth 31% 4% 9% 18% 17% 4% 7% 35%
Y/Y Growth 505% 290% 195% 114% 60% 131% 43% 43% 46% 74% 53%
Cost of Revenue (TAC) 87.6% 86% 85% 85% 85% 85.5% 88% 87% 87% 86% 87.1%

License/Other Revenue $ 45.27 $ 14.34 $ 10.54 $ 14.01 $ 16.05 $ 54.94 $ 19.18 $ 20.21 $ 22.30 $ 25.30 $ 86.99
Q/Q Growth 14% -26% -2% 52% 20% 5% 10% 13%
Y/Y Growth 58% 48% -5% 18% 27% 21% 34% 92% 59% 58% 58%

Google.com Searches (millions) 30,216 11,403 11,636 11,766 11,938 46,743 13,684 13,963 15,179 16,714 59,538
Q/Q Growth 34% 2% 3% 3% 15% 2% 9% 10%
Y/Y Growth 34% 57% 50% 52% 40% 55% 20% 20% 29% 40% 27%

Total Network Searches (millions) 23,540 12,538 11,730 11,998 12,804 49,070 14,599 14,782 15,775 19,967 65,122
Q/Q Growth 41% -6% -4% 9% 14% 1% 7% 27%
Y/Y Growth 257% 170% 88% 52% 40% 108% 20% 16% 34% 40% 33%
Network Searches (millions) 7,744 2,096 1,673 2,999 2,664 9,432 2,515 1,941 4,019 3,730 12,204
Network Factor 369% 498% 601% 300% 381% 381% 480% 662% 292% 435% 435%

PPC (Price per click) $ 0.31 $ 0.34 $ 0.36 $ 0.37 $ 0.39 $ 0.37 $ 0.41 $ 0.42 $ 0.42 $ 0.45 $ 0.43
Q/Q Growth 6% 6% 9% 8% 12% 2% 0% 7%
Y/Y Growth 9% 13% 16% 16% 28% 20% 14% 14% 8% 23% 16%

Clickthrough Rate 8.52% 7.83% 8.20% 8.20% 8.20% 8.11% 8.00% 8.00% 8.00% 7.95% 7.99%
Q/Q Growth -12% 5% 5% 0% -1% 0% 0% -1%
Y/Y Growth 15% -1% -3% -7% -8% -5% 2% -2% -2% -3% -1%

Revenue Check $ 1,466 $ 652 $ 700 $ 735 $ 807 $ 2,894 $ 947 $ 986 $ 1,062 $ 1,338 $ 4,333
Cost of Revenue Check $ 626 $ 315 $ 326 $ 343 $ 382 $ 1,367 $ 461 $ 473 $ 509 $ 671 $ 2,114

Source: Company data, CSFB estimates.

We also estimate cost of revenues for each segment. Historically, Google Web sites
cost of revenues has remained close to 9%. The majority of this cost is related to the
operation of the companys data centers and bandwidth costs.

Network Web site cost of revenues are much higher, reflecting the traffic acquisition
costs related to the AdSense program. Traffic acquisition costs are payments based on
revenue share agreements with advertisers in the Network Web sites. We estimate that
historical and future cost of revenues for this segment is approximately 85%. While we
expect this cost to increase over time as network partners play competitors for better
deals, we believe that the growth of international and the addition of smaller partners to
the network will offset this increase to some degree.

Gross Margins/Operating Margins


Exhibit 41 displays the historical and projected gross margins and operating margins for
Google. We expect gross margins to decline to approximately 50% over the next five
years, with operating margins improving from 23.4% in fiscal 2003 to approximately
30% over the same time period. However, the improvement in operating margins is

34
Google, Inc. 28 September 2004

primarily a function of the decline in stock based compensation. Excluding stock-based


compensation, operating margins are expected to decline from 39.0% in 2003 to 24.8%
in 2008.

Exhibit 41: Google Margin Analysis

90.0%

83.5%
80.0%

70.0% 70.1%
57.3%
60.0%
52.8%
51.2% 50.4% 49.5% 48.3%
50.0%
47.3%
42.4%
40.0% 39.0%
34.4%
30.0% 25.2% 26.4% 24.7%
29.2% 27.4%
27.0% 26.2% 24.8%
20.0% 26.0% 25.9%
23.4%
12.7%
10.0%

0.0%
2001 2002 2003 2004E 2005E 2006E 2007E 2008E

Gross Margins Operating Margins Operating Margin ex-Stock Based Comp

Source: Company data, CSFB estimates.

Operating Expenses
Exhibit 42 details the historical and projected breakdown of operating expenses by line
item. We expect operating expenses as a percentage of revenue to increase in the near
term as Google begins to invest more in-line with the size of its business. In fiscal 2004,
we expect Research and Development expense as a percent of revenue to reach 6.6%,
and grow to 9.7% by fiscal 2008. For Sales and Marketing expense, we expect 8.1% of
sales in fiscal 2004, increasing to 9.8% in fiscal 2008. And for General and Administrative
expense, we expect 3.6% in fiscal 2004, increasing to 4.0% in fiscal 2008.

35
Google, Inc. 28 September 2004

Exhibit 42: Google Operating Expense Breakdown


US$ millions

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$0
1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

R&D S&M G&A

Source: Company data, CSFB estimates.

Employees/Head Count
Exhibit 43 details the companys head count by operating expense line as well as by
geography. Engineering teams, typically made up of three employees, work on a
common project for four to six months, known as a Googlette. Time spent at work by
each employee is divided into three categories: 70% Core Business, 20% Brand
Extensions, and 10% Wild Ideas. Google plans to expand head count in the following
categories: over 50% engineers, slightly less than 40% nonengineers, and a small mix
of international hires. The majority of new hires will be through small acquisitions of ten
people or less, straight out of school hires or Ph.D. engineering hires. The number of
Ph.D.s working in the companys engineering corps is approximately 25% of total.

Exhibit 43: Google Head Count Breakdown


Headcount 2001 2002 2003 2004
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
G&A 37 42 50 53 60 78 95 123 175 231 264 300 350
R&D 94 105 114 124 134 162 189 214 267 353 439 487 596
S&M 67 72 85 107 145 213 271 345 447 570 703 841 961

Domestic 196 217 243 271 323 421 505 616 807 1,034 1,254 1,450 1,679
International 2 2 6 13 16 32 50 66 82 120 152 178 228

Total Employees 198 219 249 284 339 453 555 682 889 1,154 1,406 1,628 1,907

Source: Company data, CSFB estimates.

Research and Development


Research and development expenses relate to expenses incurred for the research and
development of new products and services, and for the most part is related to

36
Google, Inc. 28 September 2004

personnel. Google expenses all research and development costs. The company
expects research and development costs to rise in gross dollars as well as a percent of
revenue in fiscal 2004 and beyond owing to new hires and the introduction of new
products.

Sales and Marketing


Sales and marketing expenses relate to advertising and personnel associated with
customer service and sales. The company expects sales and marketing expenses to
increase in both dollar terms and as a percent of revenue in fiscal 2004 and beyond as
the company hires more sales and support personnel.

Stock-Based Compensation
Google has granted stock options to employees and reassesses the value of the option
grants each year. The company amortizes the compensation expense on an
accelerated basis over the remaining vesting periods for each grant, which according to
the company, is typically four or five years. The company expects stock-based
compensation expense to be $117.2 million for the remainder of fiscal 2004, $137.7
million in fiscal 2005, $66.9 million in fiscal 2006, $24.1 million in fiscal 2007, $5.2
million in fiscal 2008, and $1.7 million in fiscal 2009 and beyond.

Exhibit 44: Stock-Based Compensation Work Sheet


2003 2003 2004
Q1 Q2 Q3 Q4 FY Q1 Q2
Options granted to employees 10,262,100 1,431,552 5,785,185 1,281,895 8,760,732 1,004,780 965,520
Weighted average exercise price 0.49 3.30 5.17 9.62 16.27 38.43
Weighted average reassessed value of underyling stock 13.09 33.99 52.33 75.05 88.13 97.03
Weighted average reassessed deferred stock-based comp per option 12.60 30.69 47.16 65.43 71.86 58.60
Deferred stock-based comp related to options (in millions) 129.30 43.90 272.80 83.90 529.90 72.20 56.60
Restricted shares granted to employees 120,000 114,999 234,999 16,175
Weighted average reassessed value of restricted shares 25.96 66.41 95.09
Deferred stock-based compensation related to restricted shares (in millions) 3.10 7.60 1.50
Deferred stock-based compensation related to option modifications (in millions) 10.8 10.8 3.9
Total deferred stock-based compensation (in millions) 129.3 47.0 280.4 94.7 551.4 76.1 58.1

Source: Company data, CSFB estimates.

In some cases, the company has awarded stock options to nonemployees, for which the
company measures fair value using the Black-Scholes valuation model. As of the end of
fiscal 2003, nonemployee unvested options totaled 500,150 with a weighted average
exercise price of $0.69, a 48-month average vesting period, and weighted average 4-
year remaining expected life.

Tax Rate
Googles high tax rate is a reflection of the companys high cheap stock-based charge, a
portion of stock-based compensation that affects GAAP EPS calculations but does not
provide a tax benefit. Also, its important to note that, unlike many other Internet
companies, Google actually pays taxes. The company must calculate provisions for
income taxes including the costs and expenses related to stock-based compensation.
The company expects to reduce the stock-based compensation expenses over the next
few years, and therefore, the companys tax rate should fall accordingly toward the
statutory rate. In fiscal 2003, the companys tax rate was 69.5%, which will fall to
approximately 55% in fiscal 2004. We expect the tax rate to further decrease in fiscal
2005 to 44.8%.

37
Google, Inc. 28 September 2004

International
International currently represents 31% of the companys revenue. We anticipate that
International will eventually represent half of the companys business.

Exhibit 45: Domestic/International Revenue Breakdown


Revenue Breakdown 2001 2002 2003 1H'04
Domestic 85% 79% 74% 69%
International 15% 21% 26% 31%

Source: Company data, CSFB estimates.

Capital Expenditures
The companys capital expenditures primarily relate to the purchase of technology
assets, such as servers, data center operations, corporate facilities, and information
technology infrastructure. The company currently has over 200,000 servers, with
expected depreciable lives of 3 years. Google plans to push machine utilization. The
company spent $314 million in fiscal 2003 and expects to spend approximately $400
million in fiscal 2004. We estimate capital expenditures to increase in fiscal 2005 to
$529 million as the company continues to invest in new products and services, and
manages increases in Internet usage. We estimate that expenditures will average
approximately 40-50% of overall cash flows or 10-12% of revenues.

Days Sales Outstanding


Exhibit 46 details Googles quarterly days sales outstanding (DSO) since the first
quarter of 2001. We expect DSO to increase slightly over time as international growth
outpaces domestic advertiser growth. The companys current terms with domestic
advertisers average approximately 30 days, and international terms are usually 60-90
days.

38
Google, Inc. 28 September 2004

Exhibit 46: Quarterly DSO

DSO

60

50

40

30

20

10

-
1

4
4

1
Q

Q
Q

Q
Q

Q
01

01

02

02
01

03
01

02

02

03

03

03

04
20

20

20

20
20

20

20

20

20

20

20

20

20
Source: Company data, CSFB estimates.

Contractual Obligations
Google has entered into a number of contractual obligations, the majority of which are
guaranteed minimum revenue share payments related to the AdSense program, and
operating lease obligations. Exhibit 47 details the totals and tenors by obligation
segment.

Exhibit 47: Contractual Obligations


US$ in millions, unless otherwise stated
More than 60
Contractual Obligations as of 12/31/03 Total < 12 Months 13 - 48 Months 49 - 60 Months Months
Guaranteed minimum revenue share payments 477.0 205.1 271.9 - -
Capital lease obligations 7.4 5.3 2.1 - -
Operating lease obligations 146.7 7.4 50.9 18.8 69.6
Purchase obligations 11.9 8.8 3.1 - -
Other long-term liabilities reflected on BS under GAAP 1.5 - 0.2 0.2 1.1
Total contractual obligations 644.5 226.6 328.2 19.0 70.7

Source: Company data, CSFB estimates.

39
Google, Inc.
Exhibit 48: Income Statement
US$ in millions, unless otherwise stated
2002 2003 2003 2004 2004 2005 2005
FY-DEC Q1 Q2 Q3 Q4 Q1 Q2 Q3E Q4E Q1E Q2E Q3E Q4E
last updated: 9/20/04
GROSS REVENUE 440 249 311 394 512 1,465.9 651.6 700.2 735.0 807.3 2,894.1 946.8 986.0 1,062.4 1,337.5 4,332.7
Y/Y growth 408.5% 488.0% 296.3% 201.2% 172.6% 233.5% 162.1% 125.0% 86.6% 57.6% 97.4% 45.3% 40.8% 44.5% 65.7% 49.7%
Q/Q growth 32.3% 25.2% 26.6% 30.0% 27.2% 7.5% 5.0% 9.8% 17.3% 4.1% 7.7% 25.9%
Google web sites revenue 306.98 153.66 182.93 211.52 243.95 792.06 303.53 343.44 356.99 381.79 1,385.75 448.82 469.15 510.00 597.93 2,025.90
Y/Y growth 358.6% 158.0% 97.5% 87.7% 68.8% 56.5% 75.0% 47.9% 36.6% 42.9% 56.6% 46.2%
Google Network web sites revenue 103.94 85.68 117.27 170.42 255.23 628.60 333.75 346.23 364.02 409.46 1,453.46 478.83 496.67 530.05 714.31 2,219.86
Y/Y growth 504.8% 289.5% 195.2% 113.6% 60.4% 131.2% 43.5% 43.5% 45.6% 74.5% 52.7%
Licensing and Other revenue 28.59 9.70 11.12 11.84 12.61 45.27 14.34 10.54 14.01 16.05 54.94 19.18 20.21 22.30 25.30 86.99
Y/Y growth 46.7% 58.3% 47.8% -5.2% 18.3% 27.3% 21.4% 33.8% 91.7% 59.2% 57.7% 58.3%
Cost of Revenues 131.51 87.20 117.40 170.39 250.87 625.85 315.40 326.38 343.21 381.98 1,366.97 460.99 472.97 509.45 671.02 2,114.43
40

% of sales 29.9% 35.1% 37.7% 43.3% 49.0% 42.7% 48.4% 46.6% 46.7% 47.3% 47.2% 48.7% 48.0% 48.0% 50.2% 48.8%
GROSS PROFIT 308 161 194 224 261 840 336.2 373.8 391.8 425.3 1,527.2 485.8 513.1 552.9 666.5 2,218.3
Gross Margin 70.1% 64.9% 62.3% 56.7% 51.0% 57.3% 51.6% 53.4% 53.3% 52.7% 52.8% 51.3% 52.0% 52.0% 49.8% 51.2%
Research and Development 31.75 12.51 17.49 32.77 28.46 91.23 35.02 45.76 52.19 58.93 191.90 76.69 80.36 90.30 117.70 365.06
% of sales 7.2% 5.0% 5.6% 8.3% 5.6% 6.2% 5.4% 6.5% 7.1% 7.3% 6.6% 8.1% 8.2% 8.5% 8.8% 8.4%
Y/Y growth 102.2% 170.9% 262.0% 183.0% 187.4% 180.0% 161.6% 59.2% 107.1% 110.4% 119.0% 75.6% 73.0% 99.7% 90.2%
Sales and Marketing 43.85 17.77 24.82 36.58 41.16 120.33 47.90 56.78 62.48 67.81 234.97 83.32 89.73 99.86 129.74 402.65
% of sales 10.0% 7.1% 8.0% 9.3% 8.0% 8.2% 7.4% 8.1% 8.5% 8.4% 8.1% 8.8% 9.1% 9.4% 9.7% 9.3%
Y/Y growth 143.6% 122.1% 212.5% 201.0% 174.4% 169.6% 128.7% 70.8% 64.7% 95.3% 73.9% 58.0% 59.8% 91.3% 71.4%
General and Administrative 24.30 10.03 12.54 13.85 20.28 56.70 21.51 25.58 26.85 29.49 103.42 38.82 41.41 45.68 60.19 186.10
% of sales 5.5% 4.0% 4.0% 3.5% 4.0% 3.9% 3.3% 3.7% 3.7% 3.7% 3.6% 4.1% 4.2% 4.3% 4.5% 4.3%
Y/Y growth 142.5% 121.7% 89.4% 181.8% 133.3% 114.5% 104.0% 93.8% 45.4% 82.4% 80.5% 61.9% 70.1% 104.1% 79.9%
EBITDA 226 128 148 153 186 615.7 253.1 274.3 277.3 300.4 1,105.0 330.0 350.5 370.0 424.4 1,474.9
EBITDA Margin 51.4% 51.5% 47.5% 38.9% 36.4% 42.0% 38.8% 39.2% 37.7% 37.2% 38.2% 34.8% 35.6% 34.8% 31.7% 34.0%
Stock-based compensation 21.64 36.42 34.17 73.79 84.98 229.36 76.47 74.76 58.60 58.60 268.43 34.43 34.43 34.43 34.43 137.70
% of sales 4.9% 14.6% 11.0% 18.7% 16.6% 15.6% 11.7% 10.7% 8.0% 7.3% 9.3% 3.6% 3.5% 3.2% 2.6% 3.2%
Y/Y growth 865.0% 814.7% 1093.7% 969.8% 960.1% 110.0% 118.8% -20.6% -31.0% 17.0% -55.0% -54.0% -41.3% -41.3% -48.7%
Legal Fees - - - - - - - - 200.00 - 200.00 - - - - -
Total Costs and Expenses 253.04 163.91 206.42 327.39 425.76 1,123.47 496.30 529.25 743.32 596.81 2,365.69 694.25 718.90 779.72 1,013.08 3,205.95
OPERATING PROFIT 186 85 105 67 86 342 155.3 171.0 (8.3) 210.5 528.5 252.6 267.1 282.6 324.5 1,126.8
Operating Margin 42.4% 34.1% 33.7% 16.9% 16.9% 23.4% 23.8% 24.4% -1.1% 26.1% 18.3% 26.7% 27.1% 26.6% 24.3% 26.0%
Net interest income and other (1.55) (0.05) 0.77 0.46 3.01 4.19 0.30 (1.50) 2.00 4.00 4.80 5.00 5.00 6.00 6.00 22.00
PRETAX INCOME 185 85 106 67 89 347 155.6 169.5 (6.3) 214.5 533.3 257.6 272.1 288.6 330.5 1,148.8
Income Tax Provision 85.26 58.86 73.38 46.59 62.17 241.01 91.65 90.40 106.53 117.96 406.54 128.79 136.06 115.45 132.18 512.49
Tax Rate 46.1% 69.5% 69.5% 69.5% 69.5% 69.5% 58.9% 53.3% 55.0% 55.0% 76.2% 50.0% 50.0% 40.0% 40.0% 44.6%
NET INCOME 100 26 32 20 27 106 64.0 79.1 (112.8) 96.5 126.7 128.8 136.1 173.2 198.3 636.3
Net margin 22.7% 10.4% 10.3% 5.2% 5.3% 7.2% 9.8% 11.3% -15.4% 12.0% 4.4% 13.6% 13.8% 16.3% 14.8% 14.7%

Pro Forma EPS 0.55 0.25 0.26 0.36 0.42 1.31 0.53 0.58 0.54 0.57 2.22 0.59 0.61 0.73 0.80 2.74
GAAP Diluted EPS 0.45 0.10 0.12 0.08 0.10 0.41 0.24 0.30 (0.42) 0.35 0.47 0.47 0.48 0.61 0.69 2.25
Y/Y growth 1107.8% -8.9% 14.9% 375.5%

Common Shares 115.24 127.34 133.34 139.34 145.34 137.70 151.08 155.44 157.77 160.14 156.11 162.54 164.98 167.45 169.97 166.24
Diluted Shares 220.63 248.69 257.36 261.36 265.36 256.64 264.18 266.26 268.52 272.55 267.88 276.64 280.79 285.00 289.27 282.92

28 September 2004
Source: Company data, CSFB estimates.
Google, Inc.
Exhibit 49: Balance Sheet
US$ in millions, unless otherwise stated

2003 2004 2004 2005 2005


ASSETS Q1 Q2 Q3E Q4E Q1E Q2E Q3E Q4E
Current assets:
Cash and Equivalents 149.00 251.35 254.70 1,776.54 1,849.38 1,849.38 2,012.01 2,106.04 2,204.58 2,304.25 2,304.25
Short-term investments 185.72 203.53 293.99 293.99 293.99 293.99 293.99 293.99 293.99 293.99 293.99
Accounts receivable 154.69 179.51 191.19 211.31 229.10 229.10 271.59 298.10 336.21 374.41 374.41
Income taxes receivable - - 45.05 45.05 45.05 45.05 45.05 45.05 45.05 45.05 45.05
Deferred income taxes 22.11 15.71 30.33 30.33 30.33 30.33 30.33 30.33 30.33 30.33 30.33
Prepaid revenues 48.72 53.28 66.63 102.07 156.09 156.09 168.14 231.73 282.27 357.27 357.27
Total current assets 560.23 703.39 881.89 2,459.29 2,603.95 2,603.95 2,821.11 3,005.24 3,192.43 3,405.30 3,405.30

Property and Equipment, net 188.26 253.01 320.72 419.76 529.63 529.63 643.67 765.94 888.17 1,059.00 1,059.00
Goodwill 87.44 87.44 87.44 87.44 87.44 87.44 87.44 87.44 87.44 87.44 87.44
41

Intangible assets 18.11 18.76 16.31 15.91 14.27 14.27 16.92 22.49 20.99 18.11 18.11
Prepaid revenues (non-current) 17.41 16.87 21.66 21.66 21.66 21.66 21.66 21.66 21.66 21.66 21.66
Total Assets 871.46 1,079.45 1,328.02 3,004.06 3,256.95 3,256.95 3,590.81 3,902.77 4,210.70 4,591.51 4,591.51

LIABILITIES and S.E.


Current Liabilities
Accounts payable 46.18 37.78 61.83 69.71 87.89 87.89 93.81 119.94 141.17 173.17 173.17
Accrued compensation & benefits 33.52 23.86 33.93 40.11 51.10 51.10 47.01 70.77 89.65 115.56 115.56
Accrued expenses 26.41 34.96 41.05 47.23 58.22 58.22 54.13 77.89 96.77 122.68 122.68
Accrued revenues 88.67 99.18 93.44 96.41 93.79 93.79 102.73 113.92 119.88 130.03 130.03
Deferred revenue 15.35 15.68 18.26 20.35 23.25 23.25 28.36 34.10 37.09 41.28 41.28
Income taxes payable 20.71 83.79 - - - - - - - - -
Current portion of equipment leases 4.62 4.39 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75
Total current liabilities 235.45 299.63 252.26 277.56 318.00 318.00 329.79 420.38 488.31 586.47 586.47

Equipment leases (non-current) 1.99 1.02 0.46 0.46 0.46 0.46 0.46 0.46 0.46 0.46 0.46
Deferred revenue, long-term 5.01 5.55 6.02 6.02 6.02 6.02 6.02 6.02 6.02 6.02 6.02
Liability for stock options excercized early 6.34 7.99 8.58 8.58 8.58 8.58 8.58 8.58 8.58 8.58 8.58
Deferred income taxes 18.51 22.10 42.20 42.20 42.20 42.20 42.20 42.20 42.20 42.20 42.20
Other long-term liabilities 1.51 1.51 1.51 1.51 1.51 1.51 1.51 1.51 1.51 1.51 1.51
Redeemable convertible preferred stock warrant 13.87 13.87 - - - - - - - - -
Total liabilities 282.69 351.67 311.02 336.32 376.77 376.77 388.56 479.14 547.08 645.24 645.24

Total stockholders equity 588.77 727.78 1,017.00 2,667.74 2,880.19 2,880.19 3,202.25 3,423.63 3,663.62 3,946.27 3,946.27
Total liabilities and Stockholders Equity 871.46 1,079.45 1,328.02 3,004.06 3,256.95 3,256.95 3,590.81 3,902.77 4,210.70 4,591.51 4,591.51

28 September 2004
Source: Company data, CSFB estimates.
Google, Inc.
Exhibit 50: Cash Flow Statement
US$ in millions, unless otherwise stated

2003 2004 2004 2005 2005


Q1 Q2 Q3E Q4E Q1E Q2E Q3E Q4E
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income 105.6 64.0 79.1 (112.8) 96.5 126.7 128.8 136.1 173.2 198.3 636.3
Depreciation & amortization 43.9 21.3 28.5 27.0 31.3 108.1 43.0 49.0 53.0 65.5 210.4
Amortization of warrants 4.9 0.0 0.0 0.0 0.0 0.1 6.7 1.9 0.0 0.2 8.9
Amortization of intangibles 6.3 2.4 2.4 0.4 1.6 6.8 (2.6) (5.1) 1.6 2.9 (3.2)
In-process R&D 11.6 - 1.0 - - 1.0 - - - - -
Stock-based comp 229.4 76.5 74.8 58.6 58.6 268.4 34.4 34.4 34.4 34.4 137.7

Accounts receiveable (90.4) (24.8) (11.7) (20.1) (17.8) (74.4) (42.5) (24.3) (41.7) (38.2) (146.6)
Income taxes, net (6.3) 68.8 19.2 48.9 37.9 174.8 116.2 24.2 31.1 29.2 200.7
Prepaid revenues share, expenses and other assetes (58.9) (7.0) (60.0) (35.4) (54.0) (156.5) (12.0) (58.2) (55.3) (75.0) (200.5)
42

Accounts payable 36.7 (8.4) 24.0 7.9 18.2 41.7 5.9 23.9 23.2 32.0 85.1
Accrued expenses and other liabilities 31.1 (1.3) 13.2 6.2 11.0 29.0 (4.1) 21.8 20.6 25.9 64.2
Accrued revenues share 74.6 12.1 (7.4) 3.0 (2.6) 5.1 8.9 10.2 6.5 10.2 35.9
Deferred revenue 7.0 0.9 3.0 2.1 2.9 8.9 5.1 5.3 3.3 4.2 17.8
Net Cash from Operations 395.4 204.4 166.2 (14.4) 183.6 539.9 287.8 219.2 250.1 289.6 1,046.6

CASH FLOWS FROM INVESTING ACTIVITIES:


Capital Expenditures (176.8) (86.0) (96.2) (99.0) (109.9) (391.2) (114.0) (112.0) (133.7) (170.8) (530.5)
Purchases of short term investments (316.6) (190.4) (280.7) - - (471.1) - - - - -
Maturities and sales of short term investments 219.4 172.6 189.3 - - 361.9 - - - - -
Acquisition of businesses, net (40.0) - (3.5) - - (3.5) - - - - -
Change in other assets - - - - - - - - - - -
Net Cash from Investing (314.0) (103.9) (191.1) (99.0) (109.9) (503.9) (114.0) (112.0) (133.7) (170.8) (530.5)

CASH FLOWS FROM FINANCING ACTIVITIES AND OTHER:


Proceeds from issuance of common stock, net - - - 1,436.5 - 1,436.5 - - - - -
Proceeds from issuance of convertible preferred stock, net - - - - - - - - - - -
Proceeds from issuance of stock options, net 15.5 4.9 3.6 - - 8.6 - - - - -
Proceeds from exercise of warrants - - 21.9 - - 21.9 - - - - -
Payments of notes recievable from stockholders - - 4.3 - - 4.3 - - - - -
Payments of principle on capital leases (7.4) (1.2) (1.2) - - (2.4) - - - - -
Net cash from financing 8.1 3.7 28.6 1,436.5 - 1,468.8 - - - - -

Effect of exchange rate changes on cash 1.7 (1.9) (0.4) (1.2) (0.9) (4.4) (1.7) (1.1) 0.4 1.0 (1.3)
Change in cash and equivalents 91.2 102.4 3.3 1,321.8 72.8 1,500.4 172.1 106.1 116.8 119.7 514.8
BOP cash balance 57.8 149.0 251.4 254.7 1,576.5 149.0 1,649.4 1,821.5 1,927.6 2,044.4 1,649.4
EOP cash balance 149.0 251.4 254.7 1,576.5 1,649.4 1,649.4 1,821.5 1,927.6 2,044.4 2,164.2 2,164.2

Free Cash Flow 218.64 118.32 70.00 (113.41) 73.75 148.66 173.75 107.25 116.37 118.72 516.09

28 September 2004
Source: Company data, CSFB estimates.
Google, Inc. 28 September 2004

Valuation
Valuation is never an easy issue, particularly when dealing with a young sector like the
Internet and an even younger company like Google. Our primary method of valuation for
Google is our own discounted cash flow (DCF) model, detailed in the following.
However, for reference purposes we have also included the comparable valuations of
some technology companies and looked at the implied expectations of Googles current
valuation using the CSFB HOLT Framework.

Comparative Valuations
Unfortunately, there are rarely many applicable comparables for Internet companies and
Google is no exception. Although Yahoo and even eBay Inc. (EBAY, $88.73,
Outperform, target $100.00, Overweight) can serve because of similarities in their
business models and growth drivers, beyond that there are few reasonable comps. We
have included several media and technology companies in our analysis that might be
broadly applicable, but we believe that Yahoo, excluding its stake in Yahoo Japan
(4689, 500000.00, Underperform [V], target 500000.00, Market Weight), which we
value at 70% of market value, is the most relevant comparable.
While there are strong arguments either way, we believe that Google should trade at a
slight discount to Yahoo for the time being, as the lack of transparency, short operating
history, and less diversified business model more than offset what we believe will be a
superior growth rate at Google over the next few years. With Yahoo currently trading at
roughly 24 times our fiscal 2005 EBITDA estimate, the equivalent valuation for Google
would imply a price for GOOG of $143 based on our estimates. However, our DCF-
based $45 price target on YHOO implies a 35 times multiple (roughly equal to the
companys three-year EBITDA growth rate). Applying this same multiple to Google
results in a price of nearly $220. However, applying a media or large-cap technology-
like multiply of 13 times, would result in an $82 price. Clearly, there is a lot of ground to
be covered between the low and high ends of Googles potential comps.

43
Google, Inc.
Exhibit 51: Industry Valuation Comparison
US$ in millions, unless otherwise stated

Fiscal Year Market P/E Ratios '05 EPS EV/Sales Ratio '05 Sales TEV/EBITDA '05 EBITDA FCF FCF FCF FCF '05 FCF
Valuation Summary Value 2004E 2005E Growth 2004E 2005E Growth 2004E 2005E Growth 2004 Yield 2005 Yield Growth
Internet
AMAZON.COM 16,113 43.0 x 39.2 x 9.9% 2.5 x 2.1 x 20.9% 37.7 x 32.0 x 17.8% 531 3.3% 764 4.7% 43.8%
EBAY 59,786 73.6 x 54.0 x 36.4% 18.1 x 13.1 x 38.5% 54.8 x 37.4 x 46.4% 813 1.4% 1,010 1.7% 24.2%
EARTHLINK 1,583 12.4 x 12.0 x 3.0% 1.4 x 1.3 x 6.7% 9.5 x 8.3 x 14.6% 168 10.6% 172 10.9% 2.9%
DOUBLECLICK 760 37.3 x 25.4 x 47.3% 0.9 x 0.8 x 14.5% 60.7 x 55.3 x 9.9% 8 1.1% 37 4.8% 346.9%
1-800-FLOWERS 559 13.4 x 31.3 x -57.2% 0.8 x 0.8 x 8.0% 13.6 x 10.9 x 24.9% 32 5.6% 43 7.8% 37.3%
INTERACTIVECORP 15,861 23.6 x 18.1 x 30.6% 2.4 x 2.0 x 20.9% 13.2 x 9.7 x 36.8% 1,285 8.1% 1,480 9.3% 15.2%
NETFLIX 1,061 33.4 x 12.4 x 169.4% 1.9 x 1.1 x 64.3% 26.6 x 10.0 x 166.5% 45 4.2% 112 10.6% 151.5%
44

REALNETWORKS 752 NM 66.2 x 195.4% 1.5 x 1.2 x 21.5% 249.4 x 15.3 x 1533.2% (10) NM 14 1.9% -245.5%
YAHOO! 45,393 92.3 x 57.8 x 59.8% 16.8 x 12.0 x 39.4% 44.1 x 29.4 x 49.9% 796 1.8% 1,157 2.5% 45.4%
YAHOO! EX-JPN 39,125 92.3 x 57.8 x 59.8% 14.7 x 10.6 x 39.4% 38.7 x 25.8 x 49.9% 796 2.0% 1,157 3.0% 45.4%
Average 15,763 41.1 x 35.1 x 54.9% 5.1 x 3.8 x 26.1% 56.6 x 23.1 x 211.1% 407 4.5% 532 6.0% 30.6%

ASK JEEVES 2,077 30.4 x 22.8 x 33.3% 8.0 x 5.5 x 46.0% 24.4 x 16.6 x 47.3% 77 3.7% 77 3.7% 0.0%
GOOGLE 31,488 53.2 x 43.2 x 70.2% 10.7 x 7.1 x 97.4% 28.0 x 21.0 x 79.5% 149 0.5% 516 1.6% 247.2%

Fiscal Year Market P/E Ratios '05 EPS EV/Sales Ratio '05 Sales TEV/EBITDA '05 EBITDA FCF FCF FCF FCF '05 FCF
Valuation Summary Value 2004E 2005E Growth 2004E 2005E Growth 2004E 2005E Growth 2004 Yield 2005 Yield Growth
Large Cap Tech
MICROSOFT CORP 295,705 22.5 x 18.8 x 6.4% 6.2 x 5.9 x 5.2% 12.7 x 11.9 x 7.1% 15,952 6.8% 19,729 6.7% 23.7%
INTUIT INC 8,658 24.6 x 20.1 x 22.6% 3.9 x 3.6 x 8.3% 13.6 x 11.9 x 14.2% 388 5.2% 430 5.0% 10.7%
DELL 89,279 27.9 x 23.1 x 21.1% 1.6 x 1.4 x 15.9% 17.1 x 14.7 x 16.9% 3,704 4.1% 4,327 4.7% 16.8%
INTEL CORP 132,085 18.7 x 17.9 x 4.5% 3.5 x 3.3 x 5.5% 7.9 x 7.8 x 1.3% 8,057 6.1% 7,397 5.6% -8.2%
TEXAS INSTRUMENTS INC 38,222 22.3 x 20.0 x 11.3% 2.8 x 2.6 x 7.4% 9.5 x 8.4 x 13.1% 1,644 4.3% 2,102 5.5% 27.9%
I.B.M CORP. 143,782 17.3 x 15.5 x 11.7% 1.6 x 1.5 x 6.1% 8.9 x 8.1 x 10.6% 10,422 7.2% 11,470 7.8% 10.1%
Average 117,955 22.2 x 19.2 x 12.9% 3.2 x 3.0 x 8.1% 11.6 x 10.5 x 10.5% 6,695 5.7% 7,576 6.4% 13.2%

Fiscal Year Market P/E Ratios '05 EPS EV/Sales Ratio '05 Sales TEV/EBITDA '05 EBITDA FCF FCF FCF FCF '05 FCF
Valuation Summary Value 2004E 2005E Growth 2004E 2005E Growth 2004E 2005E Growth 2004 Yield 2005 Yield Growth
Media
Time Warner 76,255 28.5 x 20.4 x 39.9% 2.3 x 2.1 x 5.9% 10.1 x 8.5 x 12.4% 3,782 5.0% 4,503 5.9% 19.0%
Disney 48,541 22.8 x 17.2 x 32.8% 2.1 x 1.8 x 17.5% 12.2 x 9.4 x 30.0% 1,908 3.9% 2,281 4.7% 19.6%
Fox Entertainment 26,501 20.1 x 16.8 x 19.8% 1.6 x 2.0 x 9.3% 11.8 x 10.5 x 16.5% 1,189 4.5% 1,330 5.0% 11.9%
Viacom 58,380 20.5 x 18.0 x 13.6% 2.3 x 2.0 x 7.1% 9.6 x 8.4 x 8.2% 3,001 5.1% 3,395 5.8% 13.1%
Pixar 4,656 41.8 x 41.4 x 1.0% 16.4 x 13.6 x 18.0% 22.2 x 21.4 x 1.6% NA NA NA NA NA
MGM 2,861 NM -46.2 x -20.1% 1.3 x 2.1 x 6.3% NM 100.1 x 1.8% NA NA NA NA NA
Average

28 September 2004
36,199 26.7 x 11.3 x 14.5% 4.3 x 3.9 x 10.7% 13.2 x 26.4 x 11.7% 2,470 6.8% 2,877 7.9% 16.5%

Source: Company data, CSFB estimates.


Google, Inc. 28 September 2004

Discounted Cash Flow


Based on our DCF model, we are establishing a 12-month target price of $145 for
GOOG. Again, much like the model it is based on, any effort to establish a target price
on a company like GOOG should be considered more art than science. This target
would imply, based on our fiscal 2005 EBITDA estimate, a multiple of 23 times or a
forward P/E of 53 times.

Exhibit 52: DCF Valuation Summary


DCF Drivers
Cost of Capital 9.7%
Terminal Growth 6.0%
Terminal Value 91,368
Total Value 40,152
Minus Debt 0
Plus Cash 1,943
Shares Outstanding 268
Total Value 145
Source: Company data, CSFB estimates.

Clearly, long-duration companies like Google are very sensitive to changes in the
terminal growth rate and the discount rate. We have provided a do-it-yourself DCF
matrix in Exhibit 53 for investors who would like to use different assumptions in their
valuation of GOOG.

Exhibit 53: DCF Sensitivity Analysis Matrix


Sensitivity Analysis
Terminal Growth Rate
#REF! 4.0% 5.0% 6.0% 7.0% 8.0%
7.5% $176 $230 $359 $1,046 -$811
WACC 8.5% $133 $160 $208 $323 $938
9.5% $106 $121 $145 $189 $292
10.5% $88 $97 $111 $132 $171
11.5% $75 $81 $89 $102 $121

Source: Company data, CSFB estimates.

CSFB HOLT
Due to the lack of historical financial data for the company, it is very difficult to utilize the
CSFB HOLT framework linking our current model. However, we can derive what we
believe the market has embedded in the current price of GOOG using CSFB HOLT. We
have input forecasts for income statement, balance sheet, and cash flow statement
items to derive an embedded expectations analysis of GOOG, shown in Exhibit 54.

45
Google, Inc. 28 September 2004

Exhibit 54: CSFB HOLT Driver Inputs


Closing Price -

Warranted Price 120.91

Valuation Run on: 09/20/04

Company Google (GOOG) 12/2003 12/2004 12/2005 12/2006 12/2007 12/2008


2003 2004 2005 2006 2007 2008
Scenario embedded092004 USD USD USD USD USD USD
Income Statement Drivers
Organic Sales Growth 233.5% 90.0% 50.0% 35.0% 20.0% 10.0%
R&D % Sales 15.7% 6.6% 8.4% 9.5% 9.7% 9.8%
Rental % Sales 0.7% 0.7% 0.7% 0.7% 0.7% 0.7%
EBITDA Margin % 27.1% 27.0% 27.0% 27.0% 26.5% 26.0%
Interest Rate % on Avg Op Cash 1.1% 1.1% 1.1% 1.1% 1.1% 1.1%
Interest Rate % on Avg Debt 12.3% 12.3% 12.3% 12.3% 12.3% 12.3%
Non-operating Income % Sales 0.2% 0.2% 0.2% 0.2% 0.2% 0.2%
Effective Tax Rate % NPBTA 69.5% 55.4% 44.8% 38.0% 38.0% 38.0%
Dividends Per Share 0.00 0.00 0.00 0.00 0.00 0.00
Balance Sheet Drivers
Receivable Days 38.52 28.89 31.54 32.75 35.38 37.63
Inventory Days 0.00 0.00 0.00 0.00 0.00 0.00
Payable Days 11.50 11.08 14.59 16.37 18.62 20.39
Total CAPEX 177 391 529 552 645 938
Financial Structure Drivers
Operating Cash % Sales 23.6% 25.6% 22.8% 22.6% 21.9% 20.7%
Incremental Debt Issue (Repurchase) 0 0 0 0 0

Source: CSFB estimates based on CSFB HOLT framework.

The income statement inputs include organic sales growth, which we have included
through fiscal 2008. The estimates are severely discounted from our models estimates,
starting in fiscal 2004 with modest growth expectations of 80% versus 97% in our
model. The decline from 80% to 10% is also much steeper than our model. The other
significant departure from our model is the EBITDA margin, which stays relatively flat
through fiscal 2008, declining from 27.1% in fiscal 2003 to 26% in fiscal 2008.

Exhibit 55: Relative Wealth Chart


as of 9/17/04

Source: CSFB estimates based on CSFB HOLT framework.

46
Google, Inc. 28 September 2004

Exhibit 56 details the results of the inputs described for the previous exhibit. The inputs
are extremely conservative relative to our current model and DCF calculations. Using
1
the inputs, we believe the market has embedded CFROI expectations of 24.53% in
fiscal 2004, peaking in fiscal 2005 with 28.25%, and then falling to 18.04% in fiscal
2008.

For real asset growth, we believe the market has embedded expectations of 98.31% in
fiscal 2004, falling sharply to 26.73% in fiscal 2008.

Exhibit 56: Sensitivity Chart


as of 9/17/04.

Source: CSFB estimates based on CSFB HOLT framework.

Exhibit 57 details the valuation matrix given the inputs described in the embedded
expectations scenario using the CSFB HOLT framework. The CFROI and real asset
growth combinations (the top-shaded rectangles) denote combinations that satisfy the
current price scenario. The bottom-shaded rectangles show the combinations that
reflect our price target of $145.

1
CFROI is a registered trademark in the United States and other countries (excluding
the United Kingdom) of Credit Suisse First Boston or its subsidiaries or affiliates.

47
Google, Inc. 28 September 2004

Exhibit 57: Valuation Matrix


as of 9/20/04.
CFROI (T+5)
9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
13% 95.33 101.61 107.89 114.18 120.47 126.77 133.07 139.38 145.69 152.00 158.32 164.65
14% 101.12 107.83 114.54 121.26 127.99 134.72 141.45 148.19 154.93 161.68 168.43 175.19
15% 107.34 114.52 121.70 128.88 136.07 143.26 150.46 157.67 164.88 172.09 179.31 186.53
16% 114.04 121.71 129.39 137.07 144.76 152.46 160.16 167.86 175.57 183.29 191.01 198.73

Growth t+5
17% 121.25 129.45 137.67 145.89 154.12 162.35 170.58 178.83 187.08 195.33 203.59 211.85
18% 129.00 137.78 146.57 155.37 164.18 172.99 181.80 190.62 199.45 208.28 217.12 225.97
19% 137.33 146.74 156.16 165.58 175.00 184.43 193.87 203.32 212.77 222.22 231.69 241.15
20% 146.31 156.38 166.47 176.56 186.65 196.75 206.86 216.97 227.09 237.22 247.35 257.49
21% 155.97 166.76 177.56 188.37 199.19 210.01 220.84 231.67 242.51 253.36 264.21 275.07
22% 166.36 177.93 189.50 201.09 212.68 224.27 235.87 247.49 259.10 270.73 282.36 293.99
23% 177.55 189.95 202.36 214.77 227.19 239.62 252.06 264.51 276.96 289.42 301.88 314.36
24% 189.59 202.88 216.19 229.50 242.82 256.15 269.48 282.82 296.17 309.53 322.90 336.27
25% 202.55 216.81 231.08 245.35 259.64 273.93 288.23 302.54 316.85 331.18 345.51 359.85

Source: CSFB estimates based on CSFB HOLT framework.

48
Google, Inc. 28 September 2004

Risks
General Internet
The Internet sector is still in the very early stages of growth. New technologies and new
business models are being created daily, making for a less-than-stable operating
environment. Just as Google was a disruptive force created by two guys in their dorm
room, there are likely hundreds of other potential disruptive forces in the making right
now. In addition to the threat of new technologies, the Internet is prone to criminal
attacks in the form of viruses, denial of service attacks, and other malicious acts that
could threaten Internet usage in general or Google specifically.

Competition
Google faces heavy and growing competition from companies pursuing advertising
dollars in general and more specifically competitors in the online search industry. The
companys two main competitors are Yahoo and Microsoft. Over the last year Yahoo
has redoubled its efforts in search acquiring Inktomi and Overture, which acquired Alta
Vista and Fast, and it has intensified its efforts to grow its share of the search market,
including an aggressive ad campaign. In addition to competing directly for search users,
Yahoos Overture division offers advertising services that compete directly with the
AdWords and AdSense programs.

Microsoft is currently beta testing its own online search technology and plans to make
Web search a more integrated part of the Windows operating platform. Although we
believe it is unlikely that switching from one back end to another will have much impact
on Microsofts share of searches, the longer-term threat from Microsofts efforts to
integrate search into the operating system cant be understated.

Both Yahoo and Microsoft have longer relationships with clients and have longer
operating histories. Along with having many more employees than Google, they also
have a greater source of cash to fund acquisitions of increase R&D spending for new,
technologically advanced products.

Traditional media advertising companies also compete against Google for advertising
dollars. Currently, advertisers spend a very minimal portion of their total marketing
budget on online advertising. Methods such as television or newspapers are still the
predominant approach to reaching potential customers. We also expect traditional
media companies to become much more aggressive in pursuing the online opportunity.

Revenue Concentration
Almost all of Googles revenue is generated through the sale of online advertisements
and a disruption in the trend of online advertising would prove detrimental to the
business. The amount advertisers are willing to spend online directly correlates with the
health of the economy; therefore, a downturn in the economy will result in less
advertising dollars being spent.
Also, advertisers may find a more effective method of communicating to its target
market. Currently, the trend has been that people spend a significant amount of time on
the Internet, but this could change as new technologies evolve and services like

49
Google, Inc. 28 September 2004

interactive television are introduced. If that were to happen, the expected growth in
online advertising spending could fail to meet our expectations.

Voting Structure
Google has a dual-class share structure. In its initial public offering, Google offered
Class A shares, which gave shareholders one vote per share of stock owned. However,
Class B shares give the owner 10 votes per share. Currently about 83.6% of the voting
power rests with a concentrated group consisting of the Larry Page and Sergey Brin,
who control 38.1%, executive officers, directors and their affiliates, and a few other
employees. Class B shares convert to A shares as soon as they are sold. Therefore,
Class A shareholders will be highly limited in influencing corporate matters of the
company. This structure gives outside shareholders little control over the company and
could negatively affect the stocks multiple.

Transparency
Google currently plans to give no forward guidance and provide little to no operating
metrics beyond what is required by the SEC. This could result in wide variations in
analyst and market expectations and limit investors ability to fully understand the
company and its growth potential. Combined with the lack of operating history this lack
of transparency could be especially problematic. Because of this lack of transparency, it
is likely that investors will apply a discount to Googles valuationa discount that could
grow over time should the lack of transparency result in the company missing market
expectations.

Lock-Up
Google has several lock-up periods over the next 140 days as illustrated in Exhibit 58.
After lock-up periods have expired for various Class A shareholders, there could be a
potential flood of Google stock in the market, which would likely have an adverse impact
on the share price. Currently, certain shareholders have signed contractual lock-up
agreements stating they may only sell their shares once their lock-up date has passed.
Although one lock-up has already passed with little noticeable impact, future lock-up
periods are significantly larger. In addition to the impact the additional shares will have,
analysts involved in the Google offering will be restricted during the lock-up periods.

Exhibit 58: Lock-Up Agreement


Additional shares
Days after date of prospectus eligible for sale
At 15 days after the date of this prospectus and
various times thereafter 4,575,048
At 90 days after the date of this prospectus and
various times thereafter 39,081,106
At 120 days after the date of this prospectus and
various times thereafter 24,874,091
At 150 days after the date of this prospectus and
various times thereafter 24,874,091
At 180 days after the date of this prospectus and
various times thereafter 176,876,866

Source: Google S-1.

50
Google, Inc. 28 September 2004

Legal Issues
Google is currently involved in various patent and copyright legal issues, and it may be
subject to pay considerable fines depending on the outcome of these cases. Most
recently, Google was involved in a lawsuit against Overture Services, which is now
owned by Yahoo, regarding to a complaint filed by Overture stating that the Google
AdWords program infringes upon certain parts of the Overture patent. The two
companies settled this claim (and a variety of other issues) with Google giving Yahoo
2.7 million shares of Class A common stock.

51
Google, Inc. 28 September 2004

Appendix: Management

Compensation
Exhibit 59 details top executives compensation.

Exhibit 59: Executive Compensation


Summary Compensation Table 2003 Annual Compensation
Name and Principal Position Salary Bonus All Other Comp
Eric Schmidt, CEO and Director 250,000 301,556 2,894
Sergey Brin, President of Technology and Director 150,000 206,556 14,440
Larry Page, President of Products and Director 150,000 206,556 11,327
Omid Kordestani, SVP of Worldwide Sales and Field Ops 175,000 394,456 2,704
Wayne Rosing, VP of Engineering 175,000 151,314 2,704

Source: Company data.

Profiles
Dr. Eric E. Schmidt, Chairman of the Executive Committee and Chief Executive Officer
Eric Schmidt was recruited to the company from Novell, where he was the chairman and
CEO. Since coming to Google, he has focused on the development of a corporate
infrastructure suitable for this young, rapidly growing business. He also has constant
interaction with Sergey Brin and Larry Page regarding Googles daily operations. Eric
brings to Google 20 years of quality industry experience, giving him a well-rounded
perspective on the companys business decisions. Schmidt graduated with a bachelors
degree from Princeton University and a Ph.D. from the University of California-Berkeley.

Sergey Brin, Co-Founder and President, Technology


Sergey Brin co-founded Google with Larry Page in 1998. He served as the president of
the Technology division since 2001 and has been a member of the board since the
companys inception. Brin is both an achieved writer of industry topics as well as a
featured speaker at prestigious events and television programs. His research interests
include search engines, information extraction, and data mining. Sergey Brin received a
bachelors degree from the University of Maryland in mathematics and computer
science and is currently on leave from the Ph.D. program in computer science from
Stanford University.

Larry Page, Co-Founder and President, Products


Larry Page is also a co-founder. He served as the president of Products since 2001 and
has been a member of the board since the companys inception. Before that, he served
as the CEO of the company from 1998 through 2001 and as the CFO of the company
from 1998 to 2002. Page holds a masters degree in computer science from Stanford
University and a bachelors degree from the University of Michigan with a concentration
in computer engineering and, like fellow co-founder Sergey Brin, is on leave from the
Ph.D. program in computer science from Stanford University.

52
Google, Inc. 28 September 2004

George Reyes, Chief Financial Officer


George Reyes joined Google as CFO in 2002. Reyes has a broad range of experience
at several technology companies. Reyes joined Google from ONI Systems where he
served as the interim CFO and assisted in the sale of the optical networking company to
Ciena Corporation. Prior to that, he spent 13 years at Sun Microsystems, Inc. (SUNW,
$4.06, Underperform [V], target $3.25, Market Weight), where he held numerous
positions such as group controller, General Systems; director of finance, Intercontinental
Operations; audit director; vice president, Corporate Controller; and vice president,
Treasurer. Reyes holds an MBA from Santa Clara University and a bachelors degree in
accounting from the University of South Florida.

Omid Kordestani, Senior Vice President, Worldwide Sales and Field Operations
Omid Kordestani heads the international sales effort that has brought Google to
profitability in record time. Kordestani has held key positions at Netscape
Communications, including the vice president of Business Development and Sales
where he helped grow Web site revenue from $88 million to $200 million. He also was
the director of OWM Sales and established major customer relationships with well-
known companies. Kordestani received an MBA from Stanford University and a
bachelors degree in electrical engineering from San Jose State University.

53
Google, Inc. 28 September 2004

Appendix: CSFB HOLT Framework


Overview The CSFB HOLT Valuation Framework is based on two fundamental principles:
1. The market pays for economic (cash) performance and not accounting
performance.

2. The value of a company is determined by its discounted future cash flows over its
life cycle.

The CSFB HOLT methodology uses a proprietary performance measure known as



Cash Flow Return on Investment (CFROI ).

The CSFB HOLT Valuation Framework uses CFROI to estimate future cash flows and
applies a unique notion of life cycle fade to reflect the position of any individual company
on its industrial life cycle.

Exhibit 60: CSFB HOLT Framework

Accounting Cash Value


! Income Statement ! Cash Flow Return ! CFROI
on Investment
! Balance Sheet ! Asset Growth
(CFROI)
! EPS, ROE, ROCE ! Life Cycle Fade
! Economic
Performance ! Discount Rate

Source: CSFB HOLT.

Why use CFROI? Accounting statements often present a distorted view of underlying
economic performance. In order to better define a cash measure, CSFB HOLT's
Cash flow return on
economic CFROI corrects for the distortions found in traditional accounting-based
investment (CFROI)
measures of performance by adjusting for inflation, off-balance sheet assets (e.g.,
leased property), depreciation, LIFO & FIFO accounting, asset mix, asset holding gains
or losses, asset life, acquisition accounting, deferred taxes, pensions, investments,
revaluations, special reserves, research and development (R&D), and Others.

As a result, CFROI provides comparability over time, among companies, and across
industries and national borders. This proprietary measure focuses on the cash
economics of businesses. Once the economics of the company are understood, we can
more accurately determine value by taking into account expected future cash flows,
asset growth rates, discount rates, and life cycles.

54
Google, Inc. 28 September 2004

Exhibit 61: From Accounting to CFROI


Net Income (Before Extraordinary Items) Cash
+/- Special Items (after tax) + Land
+ Depreciation/Amortization Expense + Accounts Receivable
+ R&D Expense + Inventory
+ Interest Expense
+ Minority Interest Expense
+ Rental Expense $25
+/- Holding Gains (Losses)
- FIFO Profits
Non-Depreciating Assets
$10 Gross Cash Flow

CFROI
CFROI == 6.0%
6.0%
13-Year Asset Life

Book Assets
+ Accumulated Depreciation
+ Inflation Adjustment to Gross Plant
+ Inflation Adjustment to LIFO Inventory
$100 + Operating Leases
Inflation Adjusted + Capitalized R&D
Gross Investment - Goodwill
+/- Unrealized Gains/Losses on Investments
- Non-debt Monetary Liabilities & Deferred Tax Asset

Source: CSFB HOLT.

CSFB HOLT's CFROI is calculated in two steps. First, compare the inflation-adjusted
(current dollar) cash flows available to all capital owners in the company to the inflation-
adjusted (current dollar) gross investment made by those capital owners.

Next, translate the ratio of gross cash flow to gross investment to an internal rate of
return (IRR) by recognizing the finite economic life of depreciating assets and the
residual value of nondepreciating assets such as land and working capital. The process
is identical to calculating the yield to maturity for a bond. As a percent per year of IRR,
CFROI is directly comparable to the return investors expect to receive (i.e., the cost of
capital or discount rate).
Value creation Companies can create wealth for shareholders by making the right decisions with
respect to CFROI and asset growth.

As seen in the Exhibit 62, wealth is created when companies:

Improve CFROI,

Grow assets when CFROI is above the discount rate (positive spread), and

Shrink assets when CFROI is below the discount rate (negative spread).

55
Google, Inc. 28 September 2004

Exhibit 62: Managing for Shareholder Value

Positive
Spread Discount Rate
Cash Flow (Cost of Capital)
Return (%)
(CFROI) Neutral
Negative
Spread

Strategic 1. Increase or 1. Increase 1. Increase


Options hold CFROI CFROI CFROI
2. Grow Assets 2. Then Grow 2. Contract Assets

Source: CSFB HOLT.

CSFB HOLT valuation The CSFB HOLT valuation model, at its foundation, is a type of DCF (discounted cash
flow) model. Among our models distinguishing features, along with the CFROI metric, is
the way by which the forecast stream of net cash receipts (NCRs) is generated and the
method by which the firms discount rate (DR) is estimated.

From a beginning asset base, key variables that drive the forecast NCR stream are
variables that actually generate cash flowsnamely, economic returns (CFROIs),
reinvestment rates (growth), and their expected patterns of change over time due to
competition (fade). The competitive life cycle is covered on the next page.

The discount rate is the rate of return investors demand for making their funds available
to the firm. DRs used in our model are real rates, not nominal rates, so theyre
consistent with CFROIs. The DRs are also consistent with other aspects of our model,
since base DRs are mathematically derived from known market values and from NCR
streams consistent within our model. Adjustments (positive or negative) to the base rate
are made for company-specific financial and liquidity risk characteristics.

The result of discounting the NCRs at the market-derived DR is what is referred to as a


warranted value or warranted price. Essentially this is the valuation that results (or is
warranted) given the default (or users own) assumptions built into the forecast and the
resulting present value of the NCRs plus the value of any nonoperating investments.

56
Google, Inc. 28 September 2004

Exhibit 63: Major Components of the CSFB HOLT Valuation Model


Operating
Margins
Asset
Base

CFROI
n Net Cash creates

=
NPV of Existing Assets Receipts Asset
+ NPV of Future Invests Turns
(1+Disc. Rate)t
NPV of Net Cash Receipts t=1 Growth
+ MV of Non-Op. Assets Country
Total Enterprise Value Base Rate
MV of Debt Fade
Size
Total Equity Value Differential Revenue
Minority Interest Growth
Common Equity Value Leverage
Differential
Warranted Adjusted Shares
Price Com Equity / Share
Industrial Life Cycle

Source: CSFB HOLT.

Economic life cycles In evaluating CFROI and asset growth rates, CSFB HOLT found that over long periods
of time, companies tend to follow an industrial life cycle. Competition tends to force
firms real economic returns toward the corporate sectors average CFROI.

Exhibit 64: A Companys Typical Industrial Life Cycle


Increasing CFROIs & Above-Average Average Below-Average
High Reinvestment but Fading CFROIs CFROIs CFROIs

Growth Fading Mature Sick


CFROI

Discount Rate
(Investors Required
Rate of Return)

Value/Cost = High Premium Premium Par Discount

This
ThisResearch
ResearchAllows
AllowsUsUsto
toAccurately
AccuratelyAnalyze
Analyzethe
theExpected
ExpectedPattern
Patternof
of
Growth
Growthand
andFade
FadeBuilt
Builtinto
intoaaCompanys
CompanysShare
SharePrice
Price

Source: CSFB HOLT.

CSFB HOLT empirical research has found that in the U.S. and other industrialized
economies, these aggregate CFROIs have been averaging about 6%. Thus, a
warranted price or market price can be viewed as implying a firms potential future life
cycle of CFROIs and growth rates that will eventually regress to the average aggregate
economic level.

57
Google, Inc. 28 September 2004

Exhibit 65: Todays Prices Recognize That Performance Fades under Competitive
Pressures
CFROI Competitive Fade Growth Competitive Fade
Toward Corporate Average Toward Corporate Average

High CFROI Firm High Growth Firm

6.0% 2.5%

Low CFROI Firm Low Growth Firm

Competition causes CFROIs and real asset growth rates to regress to the mean (Benchmarks:
Conclusion: CFROIs = 6.0% and Asset Growth = 2.5%)
Positive and negative surprises vs fade expectations cause significant changes in stock prices

Source: CSFB HOLT.

The benefits of using the CSFB HOLTs framework can be summarized as follows.

The framework eliminates accounting distortions, allowing investors to understand


levels and changes in stock prices worldwide.

The framework provides comparability over time, among companies, and across
international borders.

CSFB HOLT users benefit from a common language for measuring track records,
making forecasts, and calibrating market expectations.

58
Google, Inc. 28 September 2004

Companies Mentioned (Price as of 24 Sep 04)


Ask Jeeves, Inc. (ASKJ, $33.00, NEUTRAL [V], TP $33.00, OVERWEIGHT)
Earthlink Inc. (ELNK, $10.33, NEUTRAL, TP $12.00, OVERWEIGHT)
eBay Inc. (EBAY, $89.22, OUTPERFORM, TP $100.00, OVERWEIGHT)
Google, Inc. (GOOG, $119.83, OUTPERFORM [V], TP $145.00, OVERWEIGHT)
Microsoft Corporation (MSFT, $27.29, NEUTRAL, TP $27.00, OVERWEIGHT)
New York Times Co. (NYT, $39.03, NEUTRAL, TP $50.00, OVERWEIGHT)
Sun Microsystems, Inc. (SUNW, $4.13, UNDERPERFORM [V], TP $3.25, MARKET WEIGHT)
Time Warner, Inc (TWX, $16.50, OUTPERFORM, TP $23.00, OVERWEIGHT)
Yahoo Inc. (YHOO, $32.58, OUTPERFORM, TP $45.00, OVERWEIGHT)
Yahoo Japan (4689, 500000.00, UNDERPERFORM [V], TP 500000.00, MARKET WEIGHT)

Disclosure Appendix
Important Global Disclosures
I, Heath P. Terry, CFA, certify that (1) the views expressed in this report accurately reflect my personal
views about all of the subject companies and securities and (2) no part of my compensation was, is or will
be directly or indirectly related to the specific recommendations or views expressed in this report.
See the Companies Mentioned section for full company names.

3-Year Price, Target Price and Rating Change History Chart for GOOG

120

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20

USD 0
1

4
/01

/02

/03
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/28

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/28
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11

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11

Closing Price Target Price Initiation/Assumption Rating


Current: O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated
Prior to 9-Sep-02: SB=Strong Buy; B=Buy; H=Hold; S=Sell; R=Restricted; NR=Not Rated

GOOG Closing Target Initiation/


Date Price (US$) Price (US$) Rating Assumption
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Underperform**: The stocks total return is expected to underperform the industry average* by 10-15% or
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relative to the relevant country index, and CSFB HOLT Small and Mid-Cap Advisor stocks, where stock
ratings are relative to the regional CSFB HOLT Small and Mid-Cap Advisor investment universe.

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Google, Inc. 28 September 2004

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See the Companies Mentioned section for full company names.
Price Target: (12 months) for (GOOG)
Method: CSFB HOLT, DCF, Multiple Analysis
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See the Companies Mentioned section for full company names.
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Important CSFB HOLT Disclosures

60
Google, Inc. 28 September 2004

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