Citi’s Mark Mahaney has always been a Google fan. And now, with the stock having cratered following Google’s withdrawal from China, failure to find a second big growth engine, and ho-hum Q1 growth, he’s doubling down:
- Adding GOOG To Citi’s Conviction Buy List — We view the 24% correction in GOOG shares YTD and its current valuation @ 14X 2010 Cash-Adjusted P/E and 12X 2011 Cash-Adjusted P/E as creating the most compelling Risk-Reward opportunity in the Large Cap Internet sector today.
- Addressing The Negative Sentiment — While issues such as Google’s withdrawal from China and negative FX & EuroZone developments have been headwind factors, we sum up the materially negative market sentiment as follows: GOOG’s Market Share Has Flatlined, GOOG’s Operating Margin Has Peaked, GOOG Will Face Aggressive Regulatory Scrutiny Going Forward, and GOOG’s New Revenue Initiatives (Mobile, Display, Video) Will Be Immaterial. We’ll take the other side.
- Has GOOG’s Market Share Flatlined? — We believe that GOOG’s market share gains will be limited going forward – esp when compared with prior years — but: a) ComScore’s April PC Search data – when adjusted for Slideshow Queries – actually suggests that Bing may be the flatliner; & b) Google’s very strong Smartphone positioning is likely to boost – not reduce – its total Search market share.
- Has GOOG’s Operating Margin Peaked? — We believe that GOOG has reentered an investment phase, but: a) As a largely fixed cost business, GOOG will continue to benefit from scale factors; b) GOOG has adopted over the past two years much more rigorous discretionary opex controls; & c) Our analysis of GOOG’s FX Hedge-adjusted Operating Margin shows more operating leverage than widely recognised.
- Will GOOG Face Aggressive Regulatory Scrutiny? — Sure it will. As it has for some time. But the FTC did approve the AdMob deal. And in our opinion, GOOG already has the assets and Brand Strength it needs to succeed in the Display (DoubleClick), Mobile (AdMob), and Video (YouTube) advertising markets.
- Will GOOG’s New Revenue Initiatives Ever Be Material? – Disclosure remains limited, but we continue to believe that GOOG can exit 2010 with a $1B-$2B Net Revenue run rate from its combined Display, Mobile, and Video segments. This means these new initiatives – which GOOG has been investing in for 5 years – are approaching 5%-10% of its total Net revenue, creating the potential to materially alter its growth rate.
- The Catalysts & The Upside – We believe a Non-UK International Macro recovery and a material contribution from GOOG’s new revenue initiatives will over the next 1-3 quarters – NOT next 1-3 years – likely to combine for a Breakout Quarter. And when they do, we see 35% upside in GOOG shares to $640 – 20X our 2011 Non-GAAP EPS or 17X our Cash-Adjusted EPS.