Wall Street Greek: Google News (Nasdaq: GOOG) - EPS Report & Strategic Insight

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Our research report takes a close look at Google's (Nasdaq: GOOG) most recent operating results, and also examines important changes occurring within the company and the web. Google reported its quarterly earnings news last evening, beating analysts EPS estimates while cautioning on coming quarters due to "uncharted economic waters" and "seasonal risk." We listened in on the search giant's conference call, which also offered valuable information for both investors and web participants of all sorts. Regardless of when you are reading this report, we think you'll find it valuable.

(Related Tickers: GOOG, YHOO, MSFT, MIVA, DIA, SPY, QQQQ, NYX, DOG, SDS, QLD, XLF, IWM, TWM, IWD, SDK).

Google News

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The Earnings Breakdown

Google earned $5.16 in its first quarter of 2009, when excluding employee stock compensation costs. The result compared favorably to the analysts' consensus forecast for $4.93 (to $4.95, depending on where you check). So why didn't the stock jump after the news then (up about 3%, and only 1% by the close)? Well, the gain was greatly driven by new cost cutting efforts and less by the double digit revenue growth the market has come to expect. Still, "given the depth of this recession," as Google aptly put it, the relative performance of the company is still above par. That said, the market does not typically reward earnings growth without revenue rise, except in a value situation where a stock may be trading at a deep discount to a normalized point or a price more relative to its peers. Google is not a value play! It's clearly a growth story, and perhaps one of the greatest of our time.

Google's first quarter revenues rose 6% over the prior year period, marking the first time growth has slipped short of double-digits in the company's short history (2004 IPO). What was worse, though still not always expected from the average company, was that sales slipped 3% versus the preceding quarter. If not for the recession, this fact would have had investors seriously reconsidering the appropriateness of GOOG's P/E ratio. The reason that did not happen was because analysts, portfolio managers and investors alike understand that the yet untapped value available to Google on the web is vast, however still hidden... and of course there is that worst economic downturn in a generation to account for.

Even so, fast growing companies do not grow at hyper speed forever. The law of large numbers dictates that growth becomes more difficult with size. Given that every company dwells within a limited universe that include subset environments, like say the United States within the greater global marketplace, then the law of large numbers plays an even greater role. You can only control 100% of a market with a specific cap to its size, and you cannot have more. But Google's web and other opportunities come from the expansion of technology, its distribution channels and its resources; and they are due to its competitive advantages, market position, intellectual property and capital resources.

No Apologies Necessary

Apologetic is a strong word; it was more like an unecessary explanation that other less than Google-like firms are required to provide shareholders. Cost cutting played a great role in the company's quarterly performance and will prove increasingly important as the company matures. That's just how the game works. So, I found it kind of funny how the management team seemed to want to appease institutional investors with its sales pitch, which noted it is still growth-focused and funding-willing. I do not think Google needs to apologize for anything.

Google ended the quarter with 58 less employees than it had at the close of Q4, marking the first time for such attrition. However, making the engine more efficient has been top priority for new CFO Patrick Pichette since he came on last summer. He's done a fine job it seems, cutting 8% off the company's operating expense line over the last quarter. Google's non-GAAP operating income margin even improved by a full point, which is more impressive when considering the revenue change in the wrong direction.

Capex

Another area of apology was capital expenditures (CapEx). Google cut its Capex significantly in the quarter, but attributed it to the normal lumpiness of this investment outflow. Here's my two cents, but who am I to criticize this greatly successful company. I can only offer thoughts, and even those are qualified, since I have not followed Google as an analyst or even read its 10K or built any model. That said, if capex is lumpy (especially on number count, versus dollar count - but still on dollar count too), I have concern that investment is not a core competency of the company. This is a common problem for companies as they grow. They're really good at what they do; they generate a lot of money doing so; and then they have trouble finding the best new uses for that capital. To make the investment process more fluid or efficient, perhaps more resources could be directed toward the investment effort. Another illness this symptom may be pointing toward is the possibility of a decision tree that may be perhaps too vertical. Again, the company might consider distributing some responsibility, but rewarding or penalizing good and poor decisions appropriately and definitively. Capex is critical to Google's future, given its huge cash store that is building. For this reason, it would be wise to build a process and a team that adequately matches against the task at hand.

The Seasonality Issue

Google discussed seasonality, preparing the market for the possibility that an ongoing recessionary environment might exacerbate the impact of seasonality. Google's operating performance is weaker in the second and third quarters of the year. The reason seems clear. Q4 is obviously a busy period for web traffic, and an intensification of that is in process with the migration of business of all sorts to the web. Secondly, human beings are more active in warmer weather, and as the Northern Hemisphere gears toward summer activities, those have not typically involved sitting in your tight and humid NYC apartment blogging (if you could see my smile...). Even yours truly fully intends to buy (or have a sponsor gift) a new laptop that might allow me to get out a bit more, not to mention travel abroad...

Google already has a cure to this seasonality. The company's global growth is opening opportunity in the Southern Hemisphere, especially in Brazil. Also, Android and the expansion of mobile search will go a long way toward leveling out the seasons. Now you can search for a restaurant while playing Frisbee in the park (be careful though)! Android, by the way, is now the second most important mobile search device, after iPhone, with 8% market share. This was clearly a good investment decision and a great use of capex. Every company just needs a steady flow of good ideas, that's all I'm saying. By the way, if your firm could use some of my wisdom, I'm available for consulting services. Simply email me at WallStreetGreek @ Gmail . com. Please see my bio to get an idea of why I believe my two cents is valuable. Executive, client and colleague referrals are available upon request.

For now though, seasonality matters. In the past, Google's excessive growth rate and market share gains have hidden the seasonal issue, but the company is established in its markets now and growth is dulled by recession. Google's management team did a good job of advising of the risk without causing a panic. Keep an eye on the sell-side now. If analysts take the full year estimate higher (or leave it be) and leave Q2 and Q3 alone in the process (or raise them), consider the risk for next quarter's report increased. This will of course depend much on the stock's point and value at that time.

Google's Wisdom on Advertising Spending

Silicon minds were fed well by the wisdom of the search expert. The recession has impacted advertising broadly speaking, but Google notes that search based advertising and "click through" ads are a different animal than the indiscriminate ad forms of old. The company advises that its clients view it as a distribution resource more than a blank marketing expense. Interest based client delivery, after all, has a better chance at sales conversion than indiscriminate ads placed for the interested and disinterested to see or ignore. Also, Google's ads deliver the client directly to the marketer's door, rather than allowing her time to forget them.

Google now has the ability to tailor its ads to your browsing habits, so that you could be on a financial website and see ads about cars, your favorite hobby. I think we all procrastinate equally well, and sometimes we click to our interests despite pressing responsibilities as sort of a stress reliever. Seems this new tool will work well toward Google's end goal.

The company also notes that the auction system it employs is working efficiently. The company says it's not losing clients, just seeing total spending come down as clients manage budgets tighter. Most importantly, web advertising continues to gain from traditional mediums.

Youtube

The company is actively seeking ways to make its costly but highly popular site, Youtube.com, monetize better. It's doing this by signing on professional producers, through which it might sell advertising to traditional buyers. In other words, you'll see the advertisers you see now on TV, also buying placement for full or partial videos available on Youtube.

With its superiority within search, it's smart extension into Android (speeding the mobile search trend), Youtube.com and future investments, we think Google remains a must own for most institutional investors and every technology fund. I like Yahoo's (Nasdaq: YHOO) shares more (and have favored them even more on the management change), but that's a valuation/special situation opportunity in my book. This note is about Google, and the search result is still tops.