Google’s 3rd Quarter Operating Results: The Foregone Conclusion That Was Amazingly Unanticipated by the Street!!!

Google hit the ball out of the park with their latest earnings
release, yet I feel the gist of their success is missed by many.
Although Google was able to increase revenues and profits on expanding
margins (a win, win, win situation), what is most impressive is that
they were able to do it while simultaneously investing in very high
risk/high reward ventures. Google TV, Android, YouTube and AdMob are the
ones that come immediately to mind. Android alone threatens to, and
actually is, disruptively transform the entire ultra mobile and mobile
computing space. The potential of Android coupled with Google’s ad
revenue subsidy prowess and plethora of cloud services is not only quite
formidable but obviously the wave of the very near future – a future
that Google is more apt to dominate than most of the technology
powerhouses of today.

On that note, I am releasing the Google Q3 2010 review for all paying subscribers (click here to subscribe):

• Google Valuation Model (pro and institutional).
• Smartphone Market Model – Blog Download Version – all paying subscribers
• Mobile Operating System Market Share Model – all paying subscribers – This model is key to showing the trends across operating systems, and not just handset manufacturers.

As is customary, I am excerpting a generous swath of the subscription
report (sans updated valuation) for free distribution on the blog…

Google Q3 results

For the quarter ended September 30, 2010 Google reported gross
revenues (before traffic acquisition costs) of $7.29bn, an YoY increase
of 22.6% and QoQ increase of 6.8% while net revenues (after traffic
acquisition costs) increased 25% YoY and by 7.7% sequentially to
$5.48bn. These results clearly demonstrate decoupling of digital economy
vis-à-vis the real economy, or put more aptly, the wholesale movement
of traditional marketing and advertising to that of the Web-based
variety.

Google continues to be a reckoning force in the online search market
commanding almost two-thirds of worldwide search queries. In Sep 2010
Google’s share of core search queries was 66.1%, the highest since
January 2009. Despite commanding over 60% of market share the company
continues to expand its share of search.  After a slight blip in May and
June, the share has increased for four straight months in a row.

All the three reporting segments and geographies delivered strong
growth rates during the quarter. Google website (66% of total) revenues
increased 22.2% YoY and 7.4% sequentially to $4.8bn while Google Network
Revenues (AdSense, 30% of total) increased 22.1% YoY and 6.6%
sequentially to $2.2bn and Licensing & other revenues increased
34.9% YoY to $254m. In terms of geographic split, both US revenues (48%
of total) and RoW (41% of total) grew 26%) and UK (11% of total)
witnessed revenue growth of by 10% (19% organic growth offset by negative currency movements).

Total cost of revenues increased at a slower pace compared with revenue growth positively impacting the margins.
Total cost of revenues excluding stock based compensation expenses
(which includes Traffic Acquisition Costs) grew 15% YoY to $2.5bn (35%
of gross revenues in Q3 2010 vs. 37.2% in Q3 2009). Traffic Acquisition
Costs grew 16% during the quarter to $1.8bn (or 25.7% of advertising
revenues) compared with $1.5bn in Q3 2009 (or 27.1% of advertising
revenues). Cost per click increased 3% YoY and 2% QoQ. Research and
development excl stock based compensation grew 33% YoY to $750m and
stood at 10.3% of revenues versus 9.5% in the previous year. Sales and
marketing expenses excl stock based compensation increased 35% YoY to
$586m, or 8.0% of revenues in Q3 2010 vs. 7.3% in Q3 2009 while general
& administrative expenses excl stock based compensation increased
39% YoY to $479m, or 6.6% of revenues in Q3 2010 vs. 5.8% a year ago.
Stock based compensation increased to $380m (5.2% of revenues) from
$318m (5.3% of revenues) in Q3 2009. Overall, income from operation
increased 23% YoY to $2.5bn with operating margin of 35%. However, due
to lower tax rate (20.2%) net income increased 32% YoY to $2.2bn, or
diluted earnings per share of $6.72 over $1.6bn in Q3 2009, or diluted
earnings per share of $5.13. Adjusted dilutive earning per share
(adjusted for stock based compensation) was $7.48 in Q3 2010 compared
with $5.90 in Q3 2009 and $6.45 in Q2 2010.

The BoomBustBlog Investment Thesis Remains Intact

As highlighted in the Google forensic report, our key investment thesis for our bullish view on Google includes:

• Secular mix shift from offline to online ad spending, and Google
  with c67% share in search market is set to benefit enormously from the
  secular mix shift though growth in search ad spend (ad words)
  • We had meticulously demonstrated the case for several of the next
    multibillion dollar business lines after search in the form of display,
    mobile and other emerging business.
• o   Increase  in share of display revenue as Google which currently
  lags Yahoo in display is ramping up its efforts through YouTube
  monetization, the DoubleClick acquisition and Teracent acquisition
• o   Opportunities in wireless search as Google goes mobile with
  Androind and AdMob. The success of Android coupled with Google’s
  traditional dominance in search advertising has laid a solid foundation
  for Google to thoroughly monetize the opportunity in the mobile space.
• o   Potential premium free call options on several new multi-billion
  revenue opportunities in the form of Google TV / Google Voice / Google
  Cloud Computing (for details refer to Google Forensic report)
• Bolt-on acquisition strategy

Given our investment thesis, Google’s consensus beat in Q3 was hardly
a surprise to us at BoomBustBlog.com. We have been persistently arguing
for higher share of display and mobile space. In Q3 revenues annaulised
revenues from display segment were $2.5bn with total revenues of $625m
for the quarter with revenue share of 8.6%.in Q3. Mobile revenues at
annualized rate were $1bn, or $250m for the quarter with revenue share
of 3.4% in Q3. We believe these numbers put a definitive end to the
argument on whether or not Google would be able to successfully monetize
Android on which we had spent considerable ink in our Forensic report.
We were however pleasantly surprised at Eric Schmidt response during
earnings conference call when he mentioned that mobile space has
potential to outgrow that of the PC market – a view which Reggie
Middleton has espoused consistently!

Eric Schmidt, CEO of Google:

“It would be I think premature to –
for us to estimate what that would be, but if you assume that search
monetization on handsets will become equivalent to PCs and then
eventually exceed it, which is my personal view, then it should be
highly lucrative, because those – the customers that are using Google
services, they are going use it more because they are more personal and
more targeted. And so ultimately, it should be a very, very strong
revenue stream compared to a PC.”

Valuation

At current price ($625) Google has already reached our base case
target price of $630 (which would have given handsome returns of 20%
since we released the report (and a return of 35% when we first
mentioned about long opportunities in Google when it as c$470). However,
unlike sell side analysts who change their target price post math the
share (studies show that actual share price is leading indicator of sell
side target price contrary to the logic that target price should be
leading indicator of actual price) we reiterate our base case valuation
of $635 (marginally up from $630 previously as a result of
stronger-than-expected Q3). As a reminder, our sell side target price of
$595 reflected Google’s fair value including online ad spend (display
and search) and mobile while our base case fair value of $635 reflected
sell side valuation plus base case valuation of  Google TV, Google Cloud
and Google Voice (assuming nominal returns from each of the returns).
That is, at $625 we believe the current price fully reflects above
opportunities. However, if one were to assume success of Google TV,
Google Cloud and Google Voice the stock could potentially reach…

The balance of this quarterly report is available here Google Q3 2010 review for all paying subscribers (click here to subscribe
or upgrade). For those wondering how the two first technology reports
released fared in terms of performance, please see below (and keep in
mind that we were contrarian on all of these calls at the time of
initial publication)…

A recent, 1 month snapshot of Google medium term calls, up nearly 350%

Excerpted from (the must read) A Quick Peek Into the REAL WORLD Logic That Went Into Building the BoomBustBlog Apple Model: It’s Called Compression!!!:

So, following up on the piece that I did just a few hours ago – Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He? along with this cute chart…

Excerpted from BoomBustBlog Research Hits Another One Out the Park! Google up nearly 10% after hours, true blowout earnings unlike JPM:

Google is seeking new revenue
streams, including searches on mobile phones. Its Android software has
surged in popularity among consumers, overtaking Research In Motion Ltd.’s BlackBerry to become the top smartphone operating system in the U.S. in the second quarter, according to research firm Gartner Inc.

Display advertising at Google is
growing as its YouTube video-watching service attracts more marketers.
The company said in May it had boosted the number of display advertisers
10-fold on YouTube.

“Our newer businesses — particularly display and mobile — continued to show significant momentum,” Chief Executive Officer Eric Schmidt said in a statement.

Display revenue is on pace to top $2.5 billion annually, Jonathan Rosenberg,
senior vice president for product management, said on the conference
call. Mobile-ad sales are on track to exceed $1 billion annually, he
said.

This is pretty much verbatim as we predicted it, and the stock and option prices are performing accordingly…

And on the short side, as excerpted from The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download:

I strongly urge all paying subscribers to read and reread the longest forensic analysis that I have ever released (@63 pages): Google Final Report, as well as the An Analysis and Valuation of Google’s Android and AdMob. Professional subscribers are strongly urged to play with all of the market and valuatin models that we have to offer (click here to subscribe):

• • Google Valuation Model (pro and institutional).
  • Smartphone Market Model – Blog Download Version – all paying subscribers
  • Mobile Operating System Market Share Model – all paying subscribers – This model is key to showing the trends across operating systems, and not just handset manufacturers.

This carries on with the strong performance of the Research in Motion
Analysis, which I am now giving away for free since it has hit our
initial price point and generated very satisfactory profits via a mix of
puts and shorts as well, see The Research In Motion Forensic Valuation and Analysis is Released to the Public…
There may be an update to this report in the near future, and if the
landscape makes a material change. For a full backgrounder of my
thoughts in this space, see below…

The Creatively Destructive Pace of Technology Innovation and the Paradigm Shift known as the Mobile Computing Wars!

1. There Is Another Paradigm Shift Coming in Technology and Media: Apple, Microsoft and Google Know its Winner Takes All
2. The Mobile Computing and Content Wars: Part 2, the Google Response to the Paradigm Shift
3. An Introduction to How Apple Apple Will Compete With the Google/Android Onslaught
4. Don’t Count Microsoft Out of the Ultra-Mobile Computing Wars Just Yet
5. This article should drive the point home: An iPhone 4 Recall Will Hurt Apple More By Opening Additional Opportunity for Android Devices Than Increased Expenses
6. A First in the Mainstream Media: Apple’s Flagship Product Loses In a Comparison Review to HTC’s Google-Powered Phone
7. After Getting a Glimpse of the New Windows Phone 7 Functionality, RIMM is Looking More Like a Short Play
8. RIM Smart Phone Market Share, RIP?
9. Android is gaining preference as the long-term choice of application developers
10. A Glimpse of the BoomBustBlog Internal Discussion Concerning the Fate of Apple
11. Math and the Pace of Smart Phone Innovation May Take a Byte Out of Apple’s (Short-lived?) Dominance
12. Apple on the Margin
13. RIM Smart Phone Market Share, RIP?
14. Motorola, the Company That INVENTED the Cellphone is Trying to Uninvent the iPad With Android
15. Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space
16. There
    Goes Those Fancy eBook Aspirations from Apple, Barnes
    and Noble, and Amazon: 100,000’s of FREE eBooks from the
    Public Library
17. How
    Google is Looking to Cut Apple’s Margin and How the
    Sell Side of Wall Street Will Enable This Without
    Sheeple Investor’s Having a Clue
18. Empirical Evidence of Android Eating Apple!
19. More of the Android Onslaught: Increasing Handset Revenues and Growth
20. Many More Black Eyes for the Blackberry? A Complete Forensic Analysis of Research in Motion
21. The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download
22. The Complete, 63 pg Google Forensic Valuation is Available for Download
23. iSuppli Continues to Validate BoomBustBlog’s Original Thesis: Android as the Viral Game Changer!
24. BoomBustBlog Research Hits Another One Out the Park! Google up nearly 10% after hours, true blowout earnings unlike JPM
25. As
    I Warned in June, DO NOT DISCOUNT Microsoft in This Mobile Computing
    War! Their Marketing Campaign is PURE GENIUS! and it Appears as if
    the Phone Ain’t Bad Either
26. Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He?
27. A Quick Peek Into the REAL WORLD Logic That Went Into Building the BoomBustBlog Apple Model: It’s Called Compression!!!

Comments

[moneymutt]

Nice Reggie...its good to see something in the market behave rationally,

[Gloomy]

ALL AMERICANS SHOULD SHORT BAC. IT IS YOUR PATRIOTIC DUTY. A JOURNEY OF ONE THOUSAND MILES STARTS WITH THE FIRST STEP.

[SheepDog-One]

Im sure Googles results will indeed be wildly underanticipated by the street with the rosiest projections yet!