Google: Fun While It Lasted

The early brouhaha about an "earnings miss" seems overblown, because much was attributable to the company's gift of $90 million to the Google Foundation and a spike in the tax rate.  This said, expenses did jump--sales and marketing especially.  Despite the marketing juice, moreover, revenue suffered the first real deceleration in a year, and more probably lies ahead.  Most importantly, for the first time since Google went public, it failed to exceed the Street's printed revenue estimates.  This suggests that near-term investor expectations have finally exceeded reality.

With respect to deceleration, the main revenue drivers over the past year have been: 1) Google Sites, and 2) International.  Year-over-year growth of Google Sites revenue had been screaming along at 110%-120% for the last four quarters.  This quarter it dropped modestly, to 107%.  While this was truly a modest drop (and still amazing performance), it came despite the company's having a full quarter of "3 term" instead of "2 term" links at the top of each search page.   International, meanwhile, had posted year-over-year growth of 130%-150% for five straight quarters through Q2.  Q3 was 120% and this quarter 102%.

One likely cause of the deceleration, in my opinion, is market saturation: After five spectacular years, the company may finally be picking the last of the low-hanging search fruit (virgin queries).  Eventually, growth will converge on the product of query growth and keyword price growth, which isn't anything like 100% a year.

When factoring out the Google Foundation gift, Free Cash Flow came in around $500 million, up about 60% year-over-year.  This is an extreme deceleration (Q3 growth was 120%, Q2 600%, and Q1 217%), and it suggests that a $3 billion estimate for 2006--at the higher end of Street expectations--is probably a stretch.  At the very least, it suggests that FCF estimates aren't going to keep rising ad infinitum. 

This, in turn, suggests that multiple compression is probably upon us.  How much?  Given the growth trajectory, 30X-40X seems more reasonable than the 50X the stock commanded a few weeks back.  And that's assuming something nastier isn't lurking over the horizon.

In any event, stay tuned for the winners of the Google Earnings Sweepstakes!

Comments

[mr fuckedgoogle]

henry, i won the prize.

check my post on your earlier thread.

the stock dropped to exactly where i said it would, afterhours.

[mr fuckedgoogle]

under the "reader consensus" post of yours, i gave a prediction at 1am yesterday:

------------------

I say earnings will be light, and the stock will plunge down to 350 within about 10 seconds of the earnings announcement in afterhours trading.

[Henry Blodget]

Will check your post! The Sweepstakes winner for the "market reaction" category will be the one who nails the opening trade, however, so we've still got about 14 hours of collective rumination/digestion to go.

[JD]

The big Goog will open at $369.25

I bet the guys at Yahoo and AOL are laughing their asses off tonight. Bad news can be so entertaining at times.

http://www.googleversus.us

[Howard]

Herny..Something good comes from your Bo Bo..We the small Joe and jane 6pack of America,now have you a top seasoned Stock analst yo show us whats real and behind the wall,your fun intresting helpful and eductional!

Your a breath of fresh air,what with all the air head stock jocks in the media,like Jim cramer..

I say she opens at 360~

[BC]

I'd use some TA to get a price point. GooG has more support than a wonderbra right now at it's 100d ema. HB's right in saying let's see where it opens at considering there isn't full institutional trading after hours. It's only traded at or under it's 100d ema a few times, so I really doubt it will break it for good. I'd put it in the 390's at the open. Don't forget that the shorts will be rushing to cover at the open.

[Bruce Braun]

No doubt, the deals with dMarc and other recent purchases were all fueled by the knowledge/fear/belief that the party was over in respect to Google’s core product.

Google is no different from a TV network. After five years, what has been Google’s core programming has becoming tired and less than dazzling. A TV network adds new shows, hopping they will find an audience and generate new incremental revenue. Google has been doing the same thing by adding Google Earth, toolbar enhancements, G-Mail etc. None of their new products has caught on with users the way the core product did. Monetization of those new products has yet to really be seen or proven over time. Up until recently, Google did not have any real strong competition in search. Search has become a mature business with a number of competing products. Search saturation can become a killer to Google’s future growth.

Google is a direct response medium. The keyword prices and revenue growth will only be as good as Google’s ability to deliver a good DR ROI at a reasonable cost. So far they have been, hence their tremendous success.

For Google, just as in TV, DR is always the early stage advertising revenue generator. As demand increases, prices go up and DR efficiency drops. In TV, brand advertising pushes DR out because the brands look at CPM or CRP, not ROI. The brands traditionally drove demand and prices up in TV.

Google has been going after brand advertising dollars but will never be able to attract or compete with the Yahoo’s or AOL’s for brand money due to a lack of content that people seek from those portals.

The dilemma for Google is that the measurement even for brands with Google will continue to be ROI. Brands have been whining about demanding better ROI from TV for at least 20 years. Moreover, every year they spend more money in TV based upon CPM’s. It is just so much hand wringing!

However, in DR, for each brand, ROI is different and they too will hit “the wall” on pricing and how much value Google provides using that criterion.

While new media throws rocks at traditional media for their pricing (the CPM’s are dead mantra), the Google’s of the world forget it the CPM that allows prices to continually rise while audiences decline.

In the CPM world, there is no ROI measurement. It is all based upon supply and demand against available audience and inventory. Witness the TV networks audiences being about 40% of their size from ten years ago but prices are 400% higher! You could never pull that one off in the pure ROI world of Google!

The Google pony needs some new tricks.

[Larry Foxx]

Henry,
The $90 million gift was backed out already. No included in the reported number.

[K]

Smart guy, predicted Google's earnings shortfall, while Wall Street sellside ANALysts remained extremely bullish: http://www.awadallah.com/blog/

[Johnny Brosco]

As much as I hate Google and all the Google pumpers this is what I see for tomorrow. I see an endless parade of CNBC talking heads mentioning how if you back down the tax rate to the assumed amount that GOOG still met or even exceeded expectations. Big institutional money has too much at stake not to pump this Piece of Crap all day long. At some point tomorrow Googe touches $400. Those that stepped up in after hours and bought will be rewarded. Possibly only for a short period of time, but they will be rewarded. It does piss me off when analyst have to over and over defend a stocks share price. I am sick and tired of these assholes telling me how cheap Google is and how over priced a company like Nektar (NKTR) is just to meet their firms personal agenda. What I love even more is they let Google trade in the 350's allowing the institutions to buy up shares on the cheap before the media made sure the public was aware that the miss was related to a tax rate change. Will be interesting to see if anyone goes postal over this.

[Javaflash]

Go back to the day of Q2/05 earning report. You will see a very identical language in press and after market reaction.

I believe the share price will rebound sooner than the street expected. Nevertheless, it's about time to get some correction underway, sweep out those hedge fund gamblers, reckless media speculations (online or offline), and allow Google to grow, experiment, innovate properly.

[Javaflash]

Mr. Brosco, let me guess, you're a webmaster somewhere. (based on your "as much as I hate Google" statement)

Involuntary competition to better quality/relevancy of your sites, hmm?

[Johnny Brosco]

No not at all. I am a trader and I run a small fund. I loved GOOG when everyone hated it and I began to hate it the day Caris analyst came on and put a $2000 target on it. I have always been susect of Safa Ratchey (sp?) also. I see him on TV and I feel like he is lying right to the worlds face. Jefferies comes across as another Wall Street Whore House as well. I am a technical trader more so than a fundamental trader. If it wasn't for all the upgrades the first trading day of 2006 this was where Google was heading anyway on New Year profit taking alone and they knew it. Those upgrades were so that they could sell. I would love to hear Henry Blodgetts opinion on that theory.

[Still Inside]

The real question here is, what is Google going to do about all of this? If they are true to their word, they are going to do NOTHING.

As an "insider" in this business, I can see three things:

First, that GOOG is going to continue to look really good on the top line for the next few quarters (at least). The money machine is working really well, and the competition is not there yet.

Second, I am willing to bet that expenses get even MORE out of control. Combine: 1) they are making tons of money; 2) they are growing wildly (LOTS of new managers); 3) the company has little/no experience with cost controls; 4) the management pro-actively disdanes stockholder value (i.e. profits, stock price, multiples, etc.). Add all of this up, and you have a company that has fiscal discipline of your average 22 year old rapper. But that's OK because they don't bow to Wall Street.

Third, although GOOG looks red-hot right now, their business model is not unique and their technology is NOT that hard to reproduce. There are NO long-term tech plays that have not built long-term "customer lock in" (MSFT, ORCL, INTC, CSCO, etc. etc. etc.). Google can be replaced by entering a new URL into your browser. And remember that they are competing not only for consumers, but for advertisers. Both markets are up for grabs for any competitor, and a massive changes can happen in just a quarter or two (and small changes that can blow their numbers for a quarter can happen in weeks).

The party is over for GOOG. I wish I got in at 85--I'd be profit-taking just like the management team is (ahem) doing now.

SI