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Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google
This is part 2 or 3 of my illustration of the gross misvaluation of Google (see My Thoughts on Roger McNamee’s View of Google and Mobile Computing).
As a reminder to our paying subscribers, on November 2010 we downgraded
the stock to Neutral from our Overweight stance while maintaining our
valuation. Given the market’s reaction to the stock and the fact that
growth was ahead of our expectations, we upgrade the stock back to
Overweight territory. The full, unabridged quarterly review is available
to all paying subscribers here: 
Google Q1 2011 results. Below are many of the salient points contained in said download.
Google Q1 results
For the quarter ended March 31, 2011 Google reported gross revenues (before traffic acquisition costs) of $8.58bn, an YoY increase of 26.6% and QoQ increase of 1.6% while net revenues (after traffic acquisition costs) increased 29.1% YoY and by 2.6% sequentially to $6.54bn. The
YoY growth in gross and net revenues was the highest at least since
2008 demonstrating a increasingly momentum in the growth of Google’s
digital ecosystem. The increase in net revenues (after
TAC) was actually stronger than the increase in gross revenues,
indicating that Google has not only packed in growth but lowered
aggregate top line expenses.
However, despite a strong set of results the stock took a severe
beating and was down c8% as the results were short of analyst
expectations. The market’s reaction to Google’s numbers clearly reflects
the very myopic view of US public markets wherein a stock is
dumped if it fails to beat consensus – even when this view clearly
overlooks the broader picture.
Google’s adjusted earnings came in at $8.08 a share below the $8.17 expected by the markets. However,
a closer look at the results reveals that the perceived shortcoming was
not a result of a revenue miss or margin compression but on account of
Google’s entrepreneurial (and quite applaudable – at least from this
investor’s perspective) endeavor to invest heavily in future projects.
The miss was principally due to higher research and development expenses
as the company continues to invest in new emerging businesses
like Display, Mobile and Enterprise. Research and development expenses
(including stock based compensation expenses) grew 50% YoY to $1.2bn and
was 14.3% of gross revenues in Q1 2011 vs. 12.5% in Q4 and 12.1% in Q1
2O10. Had research and development expenses at 12.5% of gross
revenues, the earnings would have been $8.51 per share, a clear beat to
consensus and stock would have seen a roller coaster ride –
despite the fact that future prospects would have been a fraction of
that they are now due to lower investment in the future. Google has
proven that their investments yield superior returns to that of cash
holdings, ex. Youtube, Android, Admob, Google Voice, Teracent, etc.
Instead, the stock was pushed down 8% as the shorter term players in the
market reacted. Players such as sell side analysts whose employers
benefit from the shorter horizon churning of stocks vs. a longer horizon
and outlook, and traders who act on price movement and not value,
were(are) clearly tangled between web of OPEX (ongoing cost for running a product, business, or system) and CAPEX (expenditures creating future benefits).
The eventual decrease in margins in the mobile sector will probably
accompany an increase in gross revenues for the leaders of the entire
mobile sector, as was clearly forecast in BoomBustBlog, reference Apple Gears Up To Combat The Margin Compression That Apparently Only It, Google & Reggie Middleton Sees Coming.
Thus far, Google has effectively avoided this and may avoid it for some
time due to their minimal reliance on hardware manufacturing, but it is
coming.
Google continues to be a reckoning force in the online search market commanding almost two-thirds of US search queries – and Google’s influence in its cash cow products is still expanding.
This cash cow allows Google to fund some very innovative, yet risky
ventures without materially risking or crimping excess cash flows. As of
March 2011 Google’s share of core search queries was 65.7% compared
with 65.1% a year ago, as per comScore data. Despite commanding over two
thirds of market share the company continues to hold its ground in
terms of online search queries.
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 19.7% YoY to $2.9bn
(33.7% of gross revenues in Q3 2010 vs. 36.1% in Q1 2010). Traffic
Acquisition Costs grew 19% YoY during the quarter to $2.0bn (or 24.5% of
revenues) compared with $1.7bn in Q1 2010 (or 26.4% of revenues). Cost
per click increased 8% YoY and declined 1% QoQ. Overall, gross margin
improved to 65.8% in Q1 2011 vs. 65.1% in Q4 2010 and 63.8% in Q1 2010.
Sales and marketing expenses excluding stock based
compensation increased 71% YoY to $948m, or 11% of revenues in Q1 2010
vs. 9.8% in Q4 2010 and 8.2% in Q1 2010 – a strong sign of heavy
promotional investment into new business lines! General &
administrative expenses excluding stock based compensation increased 42%
YoY to $526m, or 6.1% of revenues in Q1 2011 vs. 6.0% in Q4 2010 and
5.5% in Q1 2010. Research and development excluding stock based
compensation grew 58% YoY to $989m and was at 11.5% of revenues in Q1
2011 vs. 9.8% in Q4 2010 and 9.3% in Q1 2010 – again, a sign of very
strong business investment into new ventures. Stock based
compensation increased to $429m (5.0% of revenues) from $291m (4.3% of
revenues) in Q1 2010 and $396m (4.7% of revenues) in Q4 2010. This is a
mixed blessing. The increase in compensation needed to ward off
competitors poaching of employees is a structural expense increase – a
decided negative. The hiring of new staff during these tough economic
times to help develop and expand new multi-billion businesses is a
decided positive.
Considering all above, this investor queries, “What would one
have a tech company with a monopolistic cash cow franchise, strong
competitors and several fledgling multi-billion dollar upstart business
to do with its excess earnings? Invest them deeply into new businesses
and ventures for future value creation, or retain them as excess cash to
sit on a balance sheet which already has in excess of $30 billion of
unencumbered cash in it?”
Our investment thesis
As highlighted in the Google forensic report (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional)), our key investment thesis for our Overweight on Google were
- Secular mix shift from offline to online ad spend 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 the next multibillion
dollar business(es) after search in the form of display, mobile and
other emerging businesses. - 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 its Teracent acquisition - Opportunities in wireless search as Google goes mobile with Android
and AdMob. Success of Android coupled with Google’s traditional
dominance in search advertising has laid a solid foundation for Google
to monetize the opportunity in the mobile space. - Literally free call options on a plethora of new multi-billion
dollar revenue opportunities in the form of Google TV / Google Voice /
Google Cloud Computing (for details refer to Google Forensic report)- Bolt-on acquisition strategy
- We had meticulously demonstrated the case for the next multibillion
Valuation
The valuation and the balance of this review including the metrics
not included above are available as a download to all paying subscribers
– Google Q1 2011 results.
Next in this space, I will illustrate Google’s success rate in
building value out of its acquisition and investment strategy. If one
where to look at it from a historical perspective, one would be very
bullish on Google’s ramp up of internal and external investment… Very
bullish indeed, particularly considering the recent price drop.
- advertisements -
http://www.scroogle.org/cgi-bin/scraper.htm
http://www.scroogle.org/cgi-bin/scraper.htm
How about rising salaries? Compare Google's labor costs to Goldman's bonus structure, and Google's guys don't destroy the planet! Without R&D and good salaries there is no future.
If Google's guys don't destroy the planet, then why were they responsible for the single largest intellectual property theft attempt in the history of mankind? Google is nothing more than an incipient Goldman Sachs.
The issue at GOOG is not technology, it's leadership and management. That fat cash cow allowed them to "grow" for over a decade even though they made ridiculous blunders and suffered dead ends in many areas outside the core business. They hire extremely bright people and coddle them to the point that they become useless for anything besides ivory tower R&D. A company this size requires experienced mangers who can execute plans within budget and on a schedule, and there are darned few of those people at Google.
The recent management shakeup might change the situation, but IMO it's still too early to know.
I concur. Their only other business "Android" was in fact purchased. And since it has been in the hands of the goog it actually is floundering beyond it's base release.
The are even reneging on their "openness" now.
And I think the world is getting a bit tired of their perpetual "beta" status.
Once HP and MS start getting traction with their mobile OS's, the Goog is going to be in for a tough time, especially since those two could easily use a different mobile ad service.
Time to short Goog and long Apple
Why don't they buy back shares?
that is true I guess.
Damn you guys noticing some storms coming over your place.
I just Had a look at the FFT guys. And they are predicting a big set of tornados to come.
http://www.forecastfortomorrow.com/news/2011/04/tornado-season-look-out/
They have been VERY SPOT ON in the past...and say : "Expect it to be very bad over the next couple of days in the US mid-west, south and maybe even up toward the Canadian borders. At least one F-5 will come out of this, maybe more than one"
Stay safe people. MIght get rough.