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Google Starts 2012 with a Bang

Sejuti Banerjea

Google Inc (GOOG) started the year in style, beating our earnings estimate of $8.24 by 51 cents, or 6.2%. Revenue was more or less in line with consensus estimates of $8.1 billion.

Historically, Google has done much better than Yahoo Inc (YHOO), which has been struggling to hold its own, and Microsoft Corp (MSFT), which is yet to gain critical mass. Google’s superior algorithms have consistently attracted more users and generated better conversions.  


Google’s gross revenue touched a record $10.65 billion, representing sequential and year-over-year increases of 0.6% and 24.1%, respectively. Considering Google’s hedging program, the impact of currency was minimal on both sequential and year-over-year bases.

Google is very strongly positioned in the mobile platform, where both smartphones and tablets have been making strong headway. The dominant position has enabled Google to generate very strong mobile revenue growth. In fact, the company’s position in mobile looks better than it was in traditional computing, which says something about its strategic planning and execution.

Additionally, Google continues to benefit from the secular shift in advertising spending from offline to online properties, increasing contribution from medium and small-sized advertisers, success of the DoubleClick ad exchange, improving search algorithms and better ad quality.

Revenues from both Google-owned and partner sites continued to grow double-digits on a year-over-year basis (they have grown double-digits each quarter over the last few years). Google websites accounted for around 69% of quarterly advertising revenue, while partner sites accounted for another 27%.

Total advertising revenue was flat sequentially and up 23.0% year over year. Google-owned sites were stronger than partner sites on a year-over-year basis.

Total traffic acquisition cost (the portion of revenue shared with Google’s partners) was down 16.0% sequentially, although it continued to increase (up 24.5% from last year). However, we do not consider this a reason for concern since the traffic acquisition cost as a percentage of total advertising revenue dropped 481 basis points (bps) sequentially and was flattish when with the year-ago quarter. Net advertising revenue, excluding traffic acquisition cost was up 7.3% sequentially and 23.0% year over year.

Licensing and other fees brought in the remaining 4% of revenue in the last quarter, up 3.7% sequentially and 58.0% from the March 2011 quarter.

Total revenue excluding total traffic acquisition costs came in at $8.14 billion, just short of the Consensus Estimate of $8.15 billion.

The U.S. generated around 46% of revenue, down 11.7% sequentially and up 21.7% from a year ago. The U.K., with an 11% revenue share was up 8.5% sequentially and 18.7% from last year. Other markets accounted for the remaining 43% of revenue, representing sequential and year-over-year increases of 15.5% and 28.3%, respectively.

Google stated that Western European countries, such as the U.K., France and Germany grew strongly, with Italy remaining slightly sluggish. Additionally, growth accelerated across Asia, with Japan coming in particularly strong as it benefited from increasing contribution from the SMB segment.


The gross margin of 64.4% was down 62 bps sequentially and 136 bps from the year-ago quarter. The gross margin performance was the combined effect of revenue growth, a 7% sequential (39% year-over-year) increase in the number of paid clicks, and a 6% sequential decline (also 12% year-over-year decline) in the cost per click.

The number of paid clicks and cost per click appears significant, as they are indicative of higher volumes coming at lower prices. The mobile and emerging markets businesses are growing strongly, which could be the reason.

Other costs, associated with data center operation, amortization of intangible assets, content acquisition and credit card processing increased from the year-ago quarter, increasing the pressure on the gross margin.

Operating expenses of $3.47 billion were higher than the previous quarter’s $3.37 billion. The operating margin was 31.8%, down 130 bps from the 33.1% recorded in the previous quarter and down 77 bps from last year. R&D as a percentage of sales declined significantly from the year-ago quarter, although it was up on a sequential basis.

S&M expenses declined slightly as a percentage of sales from both the previous and year-ago quarters. Google’s recent hiring actions have been mainly focused on these two areas and it looks as if it is nearly done with its hiring activities. Other than fresh recruits, the company typically adds quite a few through acquisitions.

Non-operating gains were $156 million, up from a loss of $18 million in the previous quarter and income of $96 million in the March 2011 quarter. Google had some investment gains in the last quarter, which more than offset the impact of lower interest income.

Google reported net income of $2.89 billion, or 27.1% of sales, compared to $2.71 billion, or 25.6% of sales in the December 2011 quarter and $2.30 billion, or 26.8% of sales in the year-ago quarter. GAAP earnings of $8.75 a share were down from $8.22 in the previous quarter and $8.57 in the March quarter of 2011. There were no special items in the last quarter.

Balance Sheet

Google has a solid balance sheet, with cash and short term investments of nearly $49.3 billion, up $4.7 billion during the quarter. The company generated around $3.69 billion from operations in the last quarter and spent $607 million on capex, netting a free cash flow of $3.09 billion.

Our Take

Google reported another strong quarter, with the double-digit revenue growth driving double-digit growth in earnings. Higher non-operating income and a lower tax rate were other positives for the quarter. Management’s hiring activities appear to be tapering off, which should be a positive for earnings in the next few quarters. 

The company generates revenue primarily from the sale of advertising space on its online properties. It has therefore focused on protecting and growing its position in the search market through continued innovation and quality improvements.

This focus has ensured that it remains the dominant player in search, not just in the traditional computing segment, but even more so in the emerging mobile space. Google’s Android OS has come a long way to cementing its position in mobile. Google has also made acquisitions over time that have augmented its in-house capabilities.

With the growing importance of social networking, Google introduced Google+. While some have commented that Google will not be as popular as Facebook, this is really not that much of a concern and remains to be seen. In the meantime, it is obvious that social data will be an additional tool for Google, which has been making a number of acquisitions and innovations in the space. Management has stated that social relevance in search is resulting in better conversions.  

Toward the end of last year, Google stepped up efforts targeting the small and medium business (SMB) segment. The SMB segment has played a key role in elevating Google’s position in display and we expect the company to continue chipping away at Yahoo’s market share. Google’s success in display is very encouraging, since display advertising is expected to grow very strongly over the next few years, surpassing search advertising by 2015.

Despite the initiatives to drive growth and superb execution to date that have enabled the company to maintain share in a fast-growing market, Google’s share prices have been more or less range-bound over the last six months or so. This could be because of its many legal entanglements related to competitive matters or patent infringements, such as Oracle Corp’s (ORCL) lawsuit against it.

Google shares carry a Zacks Rank of #3, implying a short-term Hold recommendation.

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