Google’s Search for a Second Act

Jeff Macke

Google (GOOG) reports third quarter results after the bell today in one of the most highly anticipated events of this earnings season. According to Yahoo Finance the Street is expecting Google to have earned $10.65 per share on revenues of $11.9 billion. As usual, the numbers mean less than the guidance and updates on the company's growing stable of business lines.

With GOOG stock up 30% in the 3 months since their last report, traders have a lot riding on the name. In the attached clip IronFire Capital founder Eric Jackson tells Breakout what he wants to hear from the company tonight.

Core Business

Google at its core remains a search company. The metrics to watch are paid clicks and cost per click (CPC). Paid clicks are just the total number of people clicking on ads served by Google sites and the sites of its network members. The company has shown strong growth in total clicks for years, no one expects it to change now.

Cost per clicks is the challenge. CPC is the amount advertisers pay Google to funnel traffic their way. Prices there have been falling, both as a function of the Internet maturing and the relative challenge of driving mobile ads. "Even though people are using Google in the mobile world it's just not as profitable," says Jackson. At it's core Google is a search engine ad company, "everything else is just an afterthought."

Bullish Catalyst: YouTube

The most promising of the assorted under-the-headline business lines at Google is YouTube. Acquired in 2006 for about $1.8billion, YouTube spent years hosting free videos and collecting what, for Google at least, were negligible revenues. Six years later with video streaming and hosting all the rage, the YouTube deal is looking remarkably prescient.

Google is now hosting original content, both domestic and internationally. It's not going to be a profit driver immediately but online content is going to lie at the center of the evolution from passive to active television. Google has deeper pockets than most of the other content buyers without the borderline desperation of Netflix (NFLX). Glory is fleeting in emerging technologies but Google is marking it's turf.

Jackson thinks evidence of a breakthrough with YouTube could be enough to drive shares of Google to $800, should everything else come in as expected.

Bear Case: Hardware Margins

On the topic of acquisitions that make only a little bit of sense, Google recently finalized the purchase of Motorola Mobility in August. In return for $12.5 billion Google got rights to a badly lagging phone division, a set-top box division with horrific prospects, and a slew of patents. Google also got a beefy lawsuit from TiVo (TIVO) regarding patent violations for DVR technology.

It's the phones that concern Jackson. Hardware may be a necessary evil for Google to monetize its Android OS but that doesn't make handsets an attractive business. On top of inherently lousy margins, Motorola phones put Google in direct competition with partners like Samsung. A delicate situation for a company not known for being sweet.

"Inevitably that thing (Motorola) is going to drag down margins," notes Jackson. "That could be the wild card that the bears are looking for over the next couple months."

It's only one quarter but Google's strategy is constantly evolving, causing analysts to scrounge for any kernel of incremental info. Can the company justify Wall Street's love? Stay tuned.

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