As we feared, a miss (albeit on bottom line instead of top line).
Gross revenue and net revenue in line, EPS light. Most of EPS miss from interest income and higher G&A, which isn’t that big a deal. Massive CAPEX ($698 milllion) once again hammered free cash flow, which has been flat for four quarters (Where on earth is all this money going?). Revenue benefitted heavily from FOREX, and certainly wasn’t the upside surprise the Street was looking for. Sergey said the company may have overdone its quality control efforts in the quarter (reducing the number of ads), and the reversal of this could provide a modest accelerator to Q3. Stock down hard in aftermarket.
Bottom line: Far from a disaster, but clear that the days of OMG outperformance are over. In light of ongoing revenue deceleration and margin compression, stock multiple should continue to compress. We continue to think fair value is 25X-30X free cash flow ($400-$450ish on current numbers) vs. the 40X everyone has gotten used to. Won’t crater on this performance: stock will likely just be in wide trading range for a few years.
CONFERENCE CALL NOTES
4:36 ET: Call begins
(Hal Varian, chief economist on call. What’s HE going to talk about?)
Eric: “Good results” (damns with faint praise)
International to 52%, good growth Brazil and China
Paves way for explaining yet another humongous CAPEX quarter ($698 million)
Now using call to speak to Congress about Yahoo-Google deal. Call it an “ad deal, not a search deal” to hammer home Google pitch that it doesn’t have huge monopoly.
Now discussing irrelevant new features of YouTube. Now endless farewell to George Reyes. Mystery solved: Hal Varian to talk about Google-Yahoo deal and crappy economy.
GEORGE REYES takes over. Grab the coffee.
AdSense DOWN sequentially. First time ever. Attributed to quality control, seasonality.
Paid clicks DOWN sequentially. Again, first time ever. Attributed to quality control, seasonality.
UK DOWN sequentially. No FOREX benefit, seasonal weakness. Again, first time ever.
Operating margin down sequentially.
Interest income down (some of the EPS miss here). Lower cash balance from DoubleClick deal, and lower yields.
Free cash flow again hammered by massive CAPEX: Up modestly sequentially, but has essentially been flat for 4 quarters.
Queries in many sectors weak: autos, real-estate, finance, etc. Real estate down year over year. Y/Y auto ad spend up, but not on financing side (consumers hit). Consumers cautious. This is the first time Google has acknowledged weakness. Revenue performance remarkable in light of this.
Boring product details.
GOOGLE APPS: More than half a million businesses using Google Apps. Governments, etc. Growing rapidly. (Are you hearing this, Microsoft?) Is this where the big boost in licensing revenue came from?
Why did UK suck? Typical seasonality. Also, very high market share in UK, so more exposed to seasonality. [FOLKS, THIS IS A PREVIEW OF THINGS TO COME EVERYWHERE ELSE: You can’t gain more than 100% share.]
Mobile revenue per query: Will vary. Need specialised monetization. Stale example of localised advertising.
Ad coverage: It has been going down and is at all time low because of focus on quality. SERGEY: We’ve probably been too aggressive in reducing coverage in this past quarter. We now find ads are significant addition to page quality-wise. (Assume they will now reverse this, which should help next quarter).
YouTube: Happy with traffic, don’t think perfect ad format has been invented yet. OMID: Good advertisers: Lenovo, FootLocker, Ikea, etc. We’re experimenting, hope we’ll get it right someday
Crappy economy: Price sensitive consumers shopping more carefully. So we have Wal-Mart effect going on.
DoubleClick how much contributed?: Not going to say. We were brilliant to buy it, though.
DoubleClick strategy: Broad product line, integrate all. That’s happening now.
Interest income? Healthy business. Lower yields on cash balances…cash, etc.
Headcount: [Finally]. 500 new. We don’t need masses of new people anymore. A few quarters, hiring engine got ahead. We’ve now managed.
G&A: Why so high? Main increase is legal, professional, outsourcing, and fees. Possibly one-time-ish. [Here’s the rest of your earnings miss.]
YouTube: Why can’t figure this out? We are innovators. We’ve tried everything: pre roll, post roll. Lots of success with “in-view ads”. Lots of success gadget video ads, which allow you to tell story. Advertisers using this differently. New form of entertainment will have new forms of monetization. When we find it, will be huge.
PERFORMANCE ON KEY METRICS
- Gross Revenue in line: $5.37 billion (+39%) vs. $5.4 billion consensus.
- Net Revenue in line: $3.9 billion vs. $3.9 billion consensus, in line. Google Sites revenue spot on, Google Network revenue slightly light. Licensing revenue well ahead (but still tiny).
- EPS light: $4.63 vs. $4.74 consensus
Conference call at 4:30 ET / 1:30 PT. We’ll cover live.
There is far more optimism about Google this quarter than last quarter, as Comscore’s April click report was encouraging and anecdotal spending and traffic reports have been robust. That said, the Street is looking for a significant improvement in Google’s rate of revenue deceleration, and our analysis suggests that there is some downside risk to this.
In the past several quarters, Google’s revenue growth rate has decelerated rapidly, which has led to multiple compression. Wall Street expects this deceleration to slow significantly in Q2:
Year Over Year Net Revenue Growth
Q207 Y/Y: 63%
Q307 Y/Y: 62%
Q407 Y/Y: 52%
Q108 Y/Y: 46%
Q208 E: 43%
Our modelling suggests that Google will meet the consensus revenue estimate only if the US trends significantly improved in Q2. A continuation of the prior trends, meanwhile, would lead to a revenue miss. This suggest to us that there is more downside risk than upside risk to the consensus estimate.
As usual, the EPS consensus is easier: Unless Google has continued to increase spending in the face of a sharp revenue slowdown, the company should easily beat EPS consensus.
- Gross Revenue: $5.4 billion consensus, up 40%
- Net Revenue: $3.88 billion consensus, up 44% (modest deceleration from 46% in Q1)
- EPS: $4.75 (Should be plenty of upside here, unless company really blows it)
SAI Spreadsheet: Google Financial Analysis
LIVE ANALYSIS: Google Q1 Earnings, Thursday After The Close
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