Google Q3 Analysis: Rock Solid

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Call Transcript (from Seeking Alpha)

Bottom line: Another strong quarter, ahead of consensus on most key metrics.  Given that Google didn’t exist 8 years ago, in fact, it was a mind-boggling quarter–just like the previous 30-odd quarters since the company bothered to start generating revenue.  Google’s operating profit margin improved modestly (after a sharp drop last quarter).  Free cash flow was astounding, so much so that the stock’s multiple looks more reasonable.

Key points:

  • Net Revenue decelerated only modestly: 62% y/y from 63% in Q2.  As expected, the company benefited from currency conversion, but the organic deceleration was still modest.
  • Operating margin (ex stock) ticked up a point to 50% after a sharp drop last quarter.  This despite the company’s hiring 2,130 people, about 600 more than it hired last quarter and a lot more than we expected.  If/when the company decides to pull back on hiring–which comments from the call suggest it has finally done–the profit margin could leap.
  • Free cash flow hit an astounding $1.1 billion, for a annual run-rate of $4.4 billion.  For perspective, Google’s free cash flow now exceeds Time Warner’s.  And Google is 8 years old.
  • Paid clicks (revenue units) grew 45%, or 5% sequentially.  Revenue continues to grow faster than units, which means the company is benefiting each quarter from rising prices.
  • Share dilution has slowed to 2% a year: Instead of just piggishly shoveling out options, Google is looking out for existing shareholders.

Hard to find anything to worry about in the quarter, but it’s worth noting the following:  Because revenue is growing faster than units (paid clicks), the growth rate would be vulnerable to any price pressure–such as that that might result from a recession. 

Also, a lesser concern, the company’s network business (non-Google sites) actually accelerated in the quarter, to 40%, after a sharp slowdown last quarter, while the Google Sites business continued its steady deceleration trend.  The only reason this could be a concern is that click fraud is higher on the company’s network than on Google’s sites, so if click fraud ever blossoms, the company might be exposed.  But this is a trifle.

Google now has $13 billion of cash, or $41 a share.  Subtracting that from the market capitalisation (at $640) leaves you with about $190 billion, or 43-times run-rate Free Cash Flow of $4.4 billion.  That’s a fat multiple, certainly–one that leaves a lot of room for compression if the company ever stumbles.  But it’s also not an outrageous multiple.  And the market’s ongoing appreciation of this amazing company is anything but a hallucination. 


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Tidbits from Conference Call (Transcript courtesy of Seeking Alpha)

Conference call largely content free (numbers speak for themselves), but a few nuggets:

New YouTube ads working better than expected:

we have a really nice ad that shows up in the bottom 20% of the video that just overlays for a few seconds after the video starts playing and in fact, the initial user response rates have — well, the user responses and feedback have been positive and we’ve had better click-through rates than we anticipated.

TV ads going well:

TV ads, which we of course have been running now for a while. We’ve really been getting a lot of interest and bookings from advertisers. And the remarkable thing about television is, it’s surprising, but in fact of the offline advertising, it’s the one that’s closest to Internet level accountability and we feel we can bring much greater ROI type accountability to television advertising, much as we’ve done online.

The same thing is really true with the feedback mechanism that we get with set-top boxes. We are bringing the same level of granularity to the offline TV format. The trials that we have right now are with EchoStar and Astound Cable.

And what we are able to do there is we are able to show the advertisers when their spot is playing and look at the viewing levels of users actually during the course of the spot, so we are very excited about how that is playing out and we think it bodes very, very well for our progress in TV.

Google Apps adoption continuing, big partnerships [Microsoft needs to start taking this a lot more seriously.  Now]:

We’ve been seeing a lot of adoption of certain apps for your domain, apps for your university. The University of Phoenix, which is up to about 250,000 accounts now, students, faculty, employees and so forth; Northwestern is now offering it to all students, that’s on the educational front. For companies, we have a partnership now with Capgemini, which integrates Google apps into their suite of offerings and then Capgemini provides the systems integration support.

MySpace Deal (which we hear is struggling and Sergey seems to confirm):

It’s obviously a challenge because there is so much inventory, people can be distracted by very many different things and it is very personal, so there are a lot of things that make it hard. But our technology, our targeting, all those things are actually coming along very well and we are really happy. We view it as a great opportunity. I mean, it is just so much more inventory that if done correctly can create that kind of win-win I was talking about between advertisers and users.

Example of a new “Gadget Ad”.  [Tell us these aren’t going to be a monster hit]

Hiring is, in fact, going to slow.  Much of this quarter’s huge hiring boom was actually completed earlier in the year.  This suggests that margins could have meaningful upside in the next few quarters.

The numbers that you are seeing are essentially an overhang and they are an overhang from hiring that had been agreed to many, many months earlier. June, of course, is a major college hiring, university hiring, professor hiring kind of a cycle, so I don’t know that that will be repeated. The important thing here is that we did in fact correct and I think going forward, you should be comfortable that we are paying a lot of attention to the headcount.

colour on monetization improvements (higher revenue growth than click growth).  Bottom line: We saw only partial benefit from these this quarter, so Q4 should benefit significantly:

[The improved monetization] really came out of over 20 quality and UI improvements that we launched.There were two very big things that we’ve talked about publicly. The first was the reserve base promotion, and actually we only launched that in late August, so it only had part of the quarter to manifest itself in terms of improvements, and that was basically the change to the formula which determines which ads are shown above the search results, so that was certainly significant.

We’ve also been doing some things like previous query based ad targeting, which is pretty significant. We’re looking at the previous query to try to figure out what to do on the next query. So we’re pretty confident that we’ve got many, many more ad quality improvements like these. We’re also launching them internationally pretty expeditiously, so from that standpoint we think there is a very healthy pipeline in ads improvements.

Google Checkout adoption seems to be OK (no hard numbers).  This could eventually become a problem for PayPal, eBay’s strongest business.

We’ve got a big chunk of top 500 merchants. In Q3, we launched PetSmart,,, and the NHL Store. I think the real story that is important there is that many of the advertisers that we are working with, such as Jockey, are reporting much, much higher click-through rates. They achieved as much as 60% higher with Checkout and they decreased the cost-per-click by over 31% with Google AdWords and Google Checkout.

Mobile search: Growing fast, but still small.  Thus, the tremendous efforts with handset manufacturers.

On the mobile search side, our mobile searches are increasing rapidly compared to a year ago. They are growing more quickly than non-mobile searches. They are still a very small percentage of total searches, which is of great frustration to us and we are working very, very hard with some mobile operators to get Google Search to be as standard as possible on every phone — very quick and very responsive. Because we think the people using phones really want to use Google to solve interesting information problems.

Universal search may have driven some of the strong traffic this quarter (the company didn’t see the expected seasonal decline):

We are very pleased with the increases in traffic which we saw this summer, relative to the traditional seasonality. I am not sure that I can statistically attribute the causality to universal search but certainly what we are seeing is very, very favourable feedback from users. We are seeing good click-through rates particularly, as Larry mentioned, with the better integration of pieces from different data sets like book search. So as we add more books into the index and make it blend better, we certainly see higher click-throughs.

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