Google (GOOG) surprisingly solid quarter has some analysts crowing, but it hasn’t persuaded bearish Laura Martin at Media Metrics:
The key valuation question facing investors about GOOG is whether it deserves a growth stock premium or whether its earnings will prove cyclical. Despite managment’s belief of the contrary, we believe the following datapoints suggest that GOOG is already being impacted by the softening economy and a weakening advertising climate:
Falling ROICs. Net revenue margins declined 590 basis points to 49.4% (from 55.3% in 1Q07), worse than the 360 basis point y/y decline reported in 4Q07. Capital spending rose to $842mm (38% of EBITDA), up from $678mm in 4Q07 & up from $553mm in 3Q07.
1Q08 Summary: GOOG reported strong 1Q08 financial results with above consensus revenue ($3.7B vs $3.63B consensus), EBITDA ($2.16B vs $2.12B) and Operating EPS, ex stock comp ($4.84 vs $4.52). A 23% tax rate (vs consensus of 27%) represented $0.17/share added to the consensus EPS. FX represented $202mm of incremental gross revenue (500BP of growth) in 1Q08.
We expect the “Growth” valuation premium applied to Google to be lowered to a “Cyclical Growth” multiple in this cycle. There is nothing defensive about Google’s revenue line as it is virtually all advertising-linked, which is tied to economic growth. With cost growth >60% in 2007 and 49% in 1Q08, a key question is whether management will slow cost growth in a slowing revenue environment to meet EPS expectations, or will chose to power through a recession given their $12B cash horde. In 1Q08, 51% of GOOG’s revenue was offshore. Dollar devaluation won’t aid GOOG’s EPS as much in 2008 as in 2007, in our view.
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