Barron's is a weekly newspaper from Dow Jones which is well known for running negative stories on companies that cause their stocks to plummet. Barron's is very conservative--they're not known for hyping stocks that ultimately crash.

So it's especially meaningful to see Barron's forecast a Google IPO valuation well above most analysts' most optimistic projections. (See article here, requires subscription to WSJ Online.)

From the Barron's article:

Previous guesses were that Google could go public with a stock-market valuation of $20 billion or even $30 billion. But the actual number could be in the $40 billion to $50 billon range. That's a reflection of both the nature of the auction system Google will use to sell shares, and the company's financial performance, which has been even better than had been rumored....Google is growing rapidly, and producing massive profits.

Not only are Google's reported financials very strong--but the strength is actually understated:

Google is astonishingly profitable. In the March quarter, it produced pre-tax income of $155.3 million, or just under 40% of revenue. For all of 2003, the figure came to 35.6%. That's a lot more profitable than Yahoo, which in the first quarter reported a 21.2% pre-tax net margin. On the same basis, Microsoft in the March quarter reported a 24.8% margin.

Even though this is spectacular performance on its own, if you adjust for the non-cash options expense of $229M in 2003, "pre-tax margin ... jumps to 59%, a level few companies can match."

And Barron's points out that Google is using less aggresive revenue accounting than some competitors like Yahoo (see previous post on this). If Google used the same accounting rules as Yahoo, revenue would have been 67% higher in the last quarter.

The article says "Google is a cash-generation machine. In the first quarter alone, cash from operating activities totaled more than $200 million." This is a critical difference between Google and the dot-com goldrush of unprofitable companies with negative cash flow. (For an excellent primer on how to value companies using discounted cash-flow techniques, see Valuation: Measuring and Managing the Value of Companies by McKinsey.)

Barron's does the "back-of-the-envelope math": "Given Yahoo's P/E, Google's $2 of earnings would get its shares to $170, and a better-than-$50 billion valuation."

And the this could be the low end of the range: "$2 in earnings could turn out to be conservative, as it assumes profits flatten for the next three quarters."

Almost as an afterthought, the article notes challenges from "determined competitors" Microsoft and Yahoo, and says Google's "growth rate will slow and its margins shrink." And beware of the "game-theory concept called the 'winner's curse,' in which bidders win auctions by over-paying.

While Google "could be the next Microsoft -- or the next Netscape," "it would not be surprising to see Google eclipse even the most ambitious forecasts for its initial valuation."