Cause For Concern At Google?
Tuesday, April 19, 2011
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These are anxious times for longtime Google fans and investors who watched the stock continue its downward trajectory this week despite posting a first-quarter profit of more than $2.3 billion, or a little over $38 million per business day, and reporting a 27% jump in revenue to more than $6.5 billion.

It didn't help that the Mountain View, Calif.-based Internet search, advertising and mobile operating system giant also failed to meet or beat the consensus per-share profit target of $8.11, coming in at just $8.08 a share.

Google (NASDAQ: GOOG) shares tumbled more than 7% -- plunging below $550 for the first time in six months -- the day after releasing its results. Even after investors cooled off over the weekend, the stock continued its regression, falling to around $521 a share by Wednesday's close.

Besides the sharp and disconcerting spike in operating expenses, up 54% to more than $2.84 billion, it seems investors and analysts were equally put off by co-founder and recently reinstated CEO Larry Page's exceeding brief and largely meaningless contribution during the post-release conference call with analysts.

The performances of both the company and its CEO, who mostly spoke in generalities about how "excited" he was about Google's prospects and product pipelines during his 90-second cameo, was enough to bring about the unthinkable: a downgrade to a "hold" recommendation from Citigroup analyst Mark Mahaney.

"We believe Google is likely to be range-bound for the foreseeable future," Mahaney wrote in a research note Friday, adding that the sharp increase in expenses combined with "limited management disclosure suggests a lack of discipline in a growth/competitive environment that simply isn't as open-ended as it was for [Google] prior to the recession."

Mahaney also cut his 52-week price target on the ultimate tech bellwether from $750 a share to $650.

To be clear, Google doesn't appear to be in imminent danger of falling off the cliff like previous Wall Street tech darlings like AOL, Yahoo and eBay which have and still are, to varying degrees, struggling to manage expenses and define themselves and their strategies after years of unbridled growth and success.

In fact, much of Google's expenses undoubtedly were related to their continued hiring spree. The company ended the quarter with more than 26,300 employees, up from just over 20,000 a year ago and almost 2,000 in the first quarter alone. Making matters worse, at least from a balance-sheet perspective, was the fact that the first quarter included a 10 percent, across-the-board salary increase for all employees.

"The most concerning element, in our view, was management's reiteration of its disciplined approach, despite the financial results that suggest otherwise," Stifel Nicolaus analyst Jordan Rohan wrote in a research note. "That contradiction made the new Larry Page era start out with a dose of tone deafness."

Google CFO Patrick Pichette defended the rising expenses by saying the company was "really bullish on our prospects," still adheres to the financial discipline imposed for years so successfully by former CEO Eric Schmidt and requires "everybody that has a cost center to demonstrate cost productivity."

Considering its catbird position in the gigantic search and advertising market and the fact that 350,000 Android-powered mobile devices are sold each day, many analysts were willing to give Google the benefit of the doubt.

"Although Google's expense growth was higher than expected in Q1, we believe the incremental investment will likely result in strong revenue growth in 2011-2013 at high returns on invested capital," Jim Frieland, an analyst at Cowen & Co., wrote in a research note.

Caris & Co.'s Sandeep Aggarwal was also pragmatic in his post-earnings assessment.

"We believe that for every new full-time employee Google is hiring, they are also hiring one contractor and disproportionately higher resources are going in social, mobile, local and display," he wrote in a research note. "However, as long as Google can offset the margin decline by in-line type of EBITDA and EPS, in actual dollars, due to higher-than-expected, top-line growth, the stock will likely work."

Thirty-five of the 41 analysts following Google maintain either a "buy" or "strong buy" recommendation.

 

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