Google Inc. (GOOG) is expected to announce first quarter results after the bell tomorrow and estimates appear to be trending down right now. We continue to expect a moderate beat based on the positives outlined below.
Google’s market share appears stable and February numbers released by ComScore indicate that both query volumes and bid rates are on the rise. While Microsoft Corp’s (MSFT) Bing is the only search engine to have grown stronger than Google, Microsoft’s gains reflect the decline at Yahoo Inc (YHOO), indicating that it is probably picking up share from Yahoo.
On the other hand, Google continues to see relatively steady growth in paid clicks, which is what counts. The company’s instant search feature appears to be contributing to this growth, since instant allows the search engine to display most relevant paid links very quickly, drawing attention away from other links that may not be paid links.
Additionally, it appears that the EMEA (Europe, Middle East and Africa) region saw some strength in the last quarter, which bodes well for Google, since it has a dominant share of those markets as well.
Efficient Frontier has reported that the cost-per-click (“CPC”) – read that as pricing – is rising, although it was softer in March. It is obvious that Google’s search engine remains extremely effective, since advertisers have said that they are getting better return on their investments.
This is in spite of the fact that CPCs are on the rise, indicating a positive trend. The positive ROIs coupled with the improving economic climate and increased Internet usage have prompted higher advertising budgets and kept ad spending strong right through the quarter.
The mobile search business is not likely to slow down. Google has stated that this business grew 400% in 2010 and 2011 is likely to remain another strong year, if Google’s domination in the segment (97% market share according to Efficient Frontier) is anything to go by.
Google has many interesting offerings in mobile. For example, it recently joined hands with Mastercard Inc. (MA) and Citigroup Inc (C) to simplify payments through smartphones. The technology to be embedded in Android would enable users to make purchases by simply waving their phones over a reader at the checkout counters in stores.
Google recently attained regulatory approval for the acquisition of ITA Software. While this will not be reflected in first quarter numbers, it is positive for ensuing quarters, since Google will be able to offer services that can capitalize on the current strength in the e-commerce and online travel markets.
Some analysts are viewing the recent reorganization at Google negatively on account of increased uncertainties; however we remain positive. CEO Larry Page has announced six new heads for the YouTube, Chrome, Android, social-networking, web search, and advertising products, giving them greater autonomy.
We think this would allow them to focus on the job better and also adjust with competitive pressures quickly and more effectively. This will help diversify the business, lower dependence on search and drive revenue and earnings over time.
Lastly, the company has a strong cash position and no debt. It also generates a significant amount of cash from operations, providing it with significant liquidity to invest in growth within the company and pursue any acquisitions that could complement this growth.
Of course, we agree that the recent pressure on Google shares may not be without reason.
For one, Google has been and continues to be under regulatory scrutiny on multiple counts, compromise of privacy and unfair competition being the key concerns. Therefore, unfavorable restrictions may be implemented at any time that could temper its growth prospects.
Some investors may also view negatively Google’s desire to hang on to cash. Despite its solid cash position and ability to generate cash, Google remains hesitant to give some out to investors. Since the company’s average growth rate over the last five years was 38.6%, we cannot fault with this strategy.
The main reason that analysts have turned conservative about their expectations is Google’s escalating cost structure and the resultant margin pressure. Google has stepped up its efforts to retain and acquire talent. In the fourth quarter, the company announced very broad wage hikes that would increase its operating costs. Google’s decision to add new people is also becoming increasingly expensive in the current environment, where all technology companies are trying to build their resources.
As a result, there have been no positive estimate revisions in the last seven days. On the other hand, the last 30 days saw four analysts lowering estimates for the March quarter, two of which were in the last seven days. There was just one upward revision in the last 30 days.
Expectations for the June quarter look similar, with 3 downward revisions in the last 30 days, compared to two upward revisions. Sentiments have turned negative for fiscal years 2011 and 2012 as well.
As a result, the Zacks Consensus Estimate for the March quarter lost 3 cents in the last 30 days compared to a loss of 1 cent for the June quarter, 2 cents for fiscal year 2011 and 1 cent for fiscal year 2012.
To Conclude
Google had a blow-out fourth quarter, with reported earnings exceeding the Zacks Consensus Estimate by 65 cents, or 9.1%. Strong revenue, good cost control, a slightly lower tax rate were the positives for the quarter.
Promotional expenses for Google Chrome, small and mid-sized customer acquisitions, 1,000 new recruits and salary increases raised costs. Google also purchased the New York office building, which significantly lowered free cash flow. For further details, please see Google Beats Yet Again.
However, the first quarter has been eventful for the search market leader and we see multiple trends impacting its business. Google’s revenue growth will be the focal point for both investors and analysts, as this will determine whether the higher costs may be absorbed without a sacrifice to margins. We expect margin pressure, but think there could still be an excess in earnings, given strong revenue growth trends.
Google shares currently have a Zacks #3 Rank, implying a short-term Hold recommendation.
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