Google: Let the Wednesday-Morning Quarterbacking Begin

After reading the Google conference call transcript and some of the commentary, I think the important story remains the revenue deceleration, not the "earnings miss."  Still, a few smaller points jump out:

• First, CFO George Reyes attributed the tax-rate surprise to international expenses as a percent of total expenses being greater than the company expected.  Fine, but another way of saying this is that international revenue was less than expected.  Hard to spin that as positive.  Also hard to believe that the company will maintain its "no guidance" policy after George gets his head handed to him by institutional shareholders irate that the headline of every news story on the planet is "earnings miss."

• Second, Days Sales Outstanding rose a couple of days, which George attributed to international expansion and "extended credit" to some customers in the U.S.  The international expansion makes sense (credit terms tend to be longer), but why is the company granting "extended credit" to customers in the U.S.?  Usually, the explanation is "because they wouldn't have bought our services without it" or "because we don't have as much leverage as we used to."  Regardless of the explanation, it's also hard to spin that one as positive.

• Third, the fact that the company and analysts are continuing to exclude "stock-based" compensation from the "non-GAAP" earnings numbers is ridiculous.  This was defensible when the only stock-based comp was pre-IPO options.  Now that the company is showering employees with Google Stock Units, however, this portion of the expense line is unequivocally an operating expense.  The Street will do whatever it wants to do--and First Call (the company that calculates "consensus") will encourage this by refusing to consider the estimates of any principled non-herd analyst who takes a stand--but George Reyes should not start playing along.  Excluding the cost GSUs from earnings is the same as reporting "earnings before expenses."  Don't be evil, George.   

An Internet Outsider reader was kind enough to forward Goldman's earnings note, which lays out the continued bullish case.  Anthony Noto is a strong analyst (and a gracious former competitor of mine), but the main message of today's note will probably annoy a few people: Namely, "The quarter was great; the stock's only down because you idiots were expecting too much."

Now, aside from the obvious--if it was so clear that expectations were out of whack, mightn't Goldman have pointed this out when the stock was $475?--I'm not sure I agree that the quarter was great.  Also, given that this is the first quarter in the company's public-market history that revenues have been in-line with consensus, the more important point is that the consensus has finally risen enough to be in line with reality.  Since what drives stock prices is the difference between expectations and reality, this is unfortunately relevant to where the stock goes from here.

Is the stock really worth $500, as Anthony suggests?  Could the company go right back to beating expectations?  Of course--anything's possible.  It's also possible, however, that the company could follow a far more common quarterly earnings pattern: Beat, beat, beat, beat, beat...meet...miss. 

Anxiously awaiting the open to determine the winner of the second part of the Google Earnings Sweepstakes...

Comments

[Sterling]

The main issues I see with this company are growth and lack of earnings guidance from management. The two factors likely mutually exclude each other. Management finds it difficult to offer realistic guidance to the Street because it doesn't really have a way of accurately estimating its true growth rate going forward. Lacking these projections, the analyst community takes quarters like Q3 2005 as evidence of a trend acceleration in Google's revenue, earnings, and the search space in general. They started issuing higher and higher price targets based on what may have been an inflection point or at least an intermediate peak in Google's history. They zigged when they should have zagged, and now the party may be over for at least a few quarters.

This stock was able to confound analysts and skeptics since its IPO primarily because it lacked strong institutional sponsorship, which was due in large part because its earnings and business model are so hard to predict. Evidently management has not been interested in playing the guidance game or sandbagging analysts to keep expectations under control. The closest they came was Q2 2005 when they tepidly threw out a few cautionary notes about the prior year's Q3 being difficult to duplicate. As a result, this kept a lid on expectations and Q3 blew away analysts. After last October it seemed like insitutions and analysts finally viewed the risk of not participating in GOOG as being greater than the risk of owning it. Thus the run-up and multiple expansion in Q4. That didn't change the fundamental issue that this company remains a blackbox.

[JD]

You gotta love the Analysts, they are eternal optimists. Meanwhile probably not one of them has ever used Adsense, and seen what a huge fraud this is becoming. Unless Google gets that problem solved quickly this ship is going down and taking all the ass kissing analysts with it.

http://www.googleversus.us

[E. Maroulis]

Couldn't agree more with your comments on AdSense but this is an industry-wide issue not just Google. Now is there any reason as to why you have the googleversus.us domain listed here in all your posts? Especially when it's for sale at Sedo or you simply trying to make your fair share of CPC through Sedo Parking? Maybe you're just trying to show XXX numbers of visitors then dump?

[Tom]

I think that most analysts and commentators are missing the boat on the calculations about GOOG.

The potential for this company is not the inevitable decline of their current product service leaders, it is what the next big product will be that no one has thought about yet. The potential is in the way the organization works: people, style, motivation,resources, brand, thinking and scope. Just like Ford and GM lasted only so long as their enterprise was geared to surprise and delight, so Google (and Apple) are to be seen as a culture of productivity and winning big games. You don't know what's coming next. Breakthroughs on top of base strength.

Tom

[Henry Blodget]

Tom:

You're right: Google has an amazing business and an amazing platform. Their current business is so amazing, however, that I think it will be difficult for the company to pull a rabbit out of the hat that will suddenly provide a meaningful contribution to revenue. Could they grow another big business over the next five years? Absolutely. Over the next year or two, however, I doubt it. It bears noting, too, I think, that Apple's recent revival came after a decade in which it was DOA.

[Sterling]

Tom:

I agree that Google's employees and organic corporate culture are enablers of their success and innovation. There are any number of new business initiatives that could propel Google to new heights by virtue of their financial position, brand equity, media power, and the talent of their workforce. The question is how does an analyst or investor properly discount something that is currently unknown? In order to value this company with any accuracy we have to work with the variables that are known, and not speculate that lightning will strike twice in such a short span of time. It might, but how can we place a reasonable value that? That's why this is a blackbox company, IMHO.

I have heard analysts talk for a long time now about Google having so many elements (news, mail, etc.) they will monetize to grow revenues that it warrants a premium based on these alone. There is also the S&P 500 inclusion premium. It seems like so many potential revenue accelerators and market premiums have already been priced into this stock, on top of the high PEG ratio, that even if a new breakthrough is announced it is likely currently reflected in GOOG's share price.

[Patrick Chu]

To follow up on Tom's comments:

It depends on where you think we are on the Internet innovation curve, and where Google fits into that.

An illustration from history:

In 1990, Windows 3.1 came out. At the time, Microsoft stock commanded high multiples. If you were to calculate the growth curve of PCs and assume Microsoft would command 100% market share (the best case scenario), you still couldn't justify the high multiples at the time (and thus, I did not buy Microsoft stock in 1990). However, Windows 3.1 set the stage for Microsoft Office, which made them huge piles of cash, and Microsoft stock continued to perform very well for the next decade (about 100x from Jan 1990 to Jan 2000, although it's stagnant now). You could have turned $10K into a cool million during that time. And Microsoft Office revenues continue to dwarf the OS revenues.

I don't think Google guidance for the next 12 months will be very helpful in determining where the stock will go in the long term, which is good since they're not giving you any guidance anyway.

To get a glimpse of the long term, let's continue the Microsoft/Google analogy: Which version of Windows is Google on now (Windows 1.0 or 3.1 or Win95 or Win2000), and are they setting the stage for their future Microsoft Office?

My opinion: as someone running a web site for a living, I think we are in the very beginning stages of the Internet.

(I think Internet-based agent-based AI software is coming. Just a thought: what if Google could use learn your search preferences using pattern classification AI and customize the search or news results specifically for you? That's on its way in the next 10 years, either from Google or someone else. More thoughts: Why reload the whole page when you only need to refresh a part of the page? Whether you call it AJAX or use some other technology, friendly, highly-interactive Internet apps are on the way. We have barely scratch the surface of what the Internet can do).

We have a long way to go. In 10 years we'll look back at the current web sites and laugh because they will seem extremely primitive compared to what we'll have them. Google has a boatload of cash and a building of extremely smart people. They have eyeballs galore. I like their chances of finding their Microsoft Office killer app, whatever that may be.

The Googles and the Yahoos (and even MSN) have a long way to go before the Internet matures and the returns level off. Even at these multiples, I would not short GOOG. I learned my lesson shorting AOL in the mid-90's.

Disclosure: My wife and I are only invested in index mutual funds. We own no individual stocks at all in our portfolio.

[mayday]

henry,
i couldnt disagree w/ you more on including options expense in earnings. the fasb 123 rule was instituted for corporate governance reasons and the debate w/in the accounting community was intense - and rightly so. now, w/ fasb 123, options expense is DOUBLE COUNTED on the GAAL P&L (EPS) - once as on operating expense and again as a dilution to shares outstanding.

[Thomas J]

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Thomas J

[Travis]

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I will contact Google and this site will be grey barred if you don't do the right thing.

Travis