Thursday, 28 April 2011 12:26

A Realistic Look At The Success Of Google's Investment History

As promised, I am presenting historical justification of the logic behind my call of absurdity in the drastic drop in share price after Google announces a redoubled effort in investment and marketing of its nascent businesses. I went into the logic in detail via our Google Q1 2011 earnings review - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google. The following pages are excerpted the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).

To begin with, Google apparently realized early on that it could better realize returns by investing shareholder capital through acquisitions. It has actually been quite acquisitive, making 88 purchases over the last 13 year. Last year was Google's most acquisitive year, ever!

While many of the referenced acquisitions have been to bolster existing products, several have literally become home runs - rising to the top of their respective categories and even threatening to go farther in that hey have the distinct potential to creatively destroy the status quo of several multi-billion dollar industries. Let's walk through a sampling.

Doubleclick + Youtube + Google TV (organically grown)

This combination is probably the closest thing to a direct replacement for TV as we know it. Even if Google TV does not succeed, YouTube is currently the most watched video site, by far and Doubleclick (for monetization, along with adsense style ads) is the 2nd largest display ad entity. Again, the potential to reconfigure the TV industry. Google is already seed funding original content and cutting licensing (streaming rental) deals with the large established studios. The ability to threaten TV as we know it was purchased for just over $1 billion. A pretty good investment, no? Would the NY Times parent co., Fox, Disney, NBC/Universal have considered this a wise purchase?

Admob and Android

For a mere $250 million (plus ongoing support and development costs and investments), Google now commands the largest global footprint of mobile phone OS, the fastest global mobile phone OS growth rate, the largest (by a very, very wide margin) mobile ad presence, and inarguably the most disruptive force in mobile computing. What tech, media, telecomm or strategic investment company would NOT by the Android/Admob combo now for 10xor eve 15x what Google paid for it? Microsoft, Nokia, Apple, Samsung, LG, RIM, Oracle, IBM, HP, anyone???

The list of strategic acquisitions that have paid off in spades goes on, as well as the requisite flops that go along with a high volume strategy.

So, assuming that Google has done a good job at spending its shareholder's money and sprouting several billion dollar businesses to assist in the diversification away from pure web search advertising - and realizing that last year was Google's most acquisitive to date, and realizing that Google is dumping more money into research, marketing, headcount and acquisitions now than in any time in its existence (including last year), should you be bullish on the stock? Three or four more Androids, YouTubes, Admobs and Doubleclicks to disruptively take over 5 or six more multi-billion dollar industries is a reason to lop 15% off of this stocks price (which currently barely accounts for just the search engine potential)???

As excerpted from Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google:

For the quarter ended March 31, 2011 Google reported gross revenues (before traffic acquisition costs) of $8.58bn, an YoY increase of 26.6% and QoQ increase of 1.6% while net revenues (after traffic acquisition costs) increased 29.1% YoY and by 2.6% sequentially to $6.54bn. The YoY growth in gross and net revenues was the highest at least since 2008 demonstrating a increasingly momentum in the growth of Google’s digital ecosystem. The increase in net revenues (after TAC) was actually stronger than the increase in gross revenues, indicating that Google has not only packed in growth but lowered aggregate top line expenses.

However, despite a strong set of results the stock took a severe beating and was down c8% as the results were short of analyst expectations. The market’s reaction to Google’s numbers clearly reflects the very myopic view of US public markets wherein a stock is dumped if it fails to beat consensus – even when this view clearly overlooks the broader picture.

Google’s adjusted earnings came in at $8.08 a share below the $8.17 expected by the markets. However, a closer look at the results reveals that the perceived shortcoming was not a result of a revenue miss or margin compression but on account of Google’s entrepreneurial (and quite applaudable – at least from this investor’s perspective) endeavor to invest heavily in future projects. The miss was principally due to higher research and development expenses as the company continues to invest in new emerging businesses like Display, Mobile and Enterprise. Research and development expenses (including stock based compensation expenses) grew 50% YoY to $1.2bn and was 14.3% of gross revenues in Q1 2011 vs. 12.5% in Q4 and 12.1% in Q1 2O10. Had research and development expenses at 12.5% of gross revenues, the earnings would have been $8.51 per share, a clear beat to consensus and stock would have seen a roller coaster ride – despite the fact that future prospects would have been a fraction of that they are now due to lower investment in the future. Google has proven that their investments yield superior returns to that of cash holdings, ex. Youtube, Android, Admob, Google Voice, Teracent, etc. Instead, the stock was pushed down 8% as the shorter term players in the market reacted. Players such as sell side analysts whose employers benefit from the shorter horizon churning of stocks vs. a longer horizon and outlook, and traders who act on price movement and not value, were(are) clearly tangled between web of OPEX (ongoing cost for running a product, business, or system) and CAPEX (expenditures creating future benefits).


Google continues to be a reckoning force in the online search market commanding almost two-thirds of US search queries – and Google’s influence in its cash cow products is still expanding. This cash cow allows Google to fund some very innovative, yet risky ventures without materially risking or crimping excess cash flows. As of March 2011 Google’s share of core search queries was 65.7% compared with 65.1% a year ago, as per comScore data. Despite commanding over two thirds of market share the company continues to hold its ground in terms of online search queries.


Total cost of revenues increased at a slower pace compared with revenue growth positively impacting the margins. Total cost of revenues excluding stock based compensation expenses (which includes Traffic Acquisition Costs) grew 19.7% YoY to $2.9bn (33.7% of gross revenues in Q3 2010 vs. 36.1% in Q1 2010). Traffic Acquisition Costs grew 19% YoY during the quarter to $2.0bn (or 24.5% of revenues) compared with $1.7bn in Q1 2010 (or 26.4% of revenues). Cost per click increased 8% YoY and declined 1% QoQ. Overall, gross margin improved to 65.8% in Q1 2011 vs. 65.1% in Q4 2010 and 63.8% in Q1 2010.

Sales and marketing expenses excluding stock based compensation increased 71% YoY to $948m, or 11% of revenues in Q1 2010 vs. 9.8% in Q4 2010 and 8.2% in Q1 2010 - a strong sign of heavy promotional investment into new business lines! General & administrative expenses excluding stock based compensation increased 42% YoY to $526m, or 6.1% of revenues in Q1 2011 vs. 6.0% in Q4 2010 and 5.5% in Q1 2010. Research and development excluding stock based compensation grew 58% YoY to $989m and was at 11.5% of revenues in Q1 2011 vs. 9.8% in Q4 2010 and 9.3% in Q1 2010 - again, a sign of very strong business investment into new ventures. Stock based compensation increased to $429m (5.0% of revenues) from $291m (4.3% of revenues) in Q1 2010 and $396m (4.7% of revenues) in Q4 2010. This is a mixed blessing. The increase in compensation needed to ward off competitors poaching of employees is a structural expense increase - a decided negative. The hiring of new staff during these tough economic times to help develop and expand new multi-billion businesses is a decided positive.

Considering all above, this investor queries, "What would one have a tech company with a monopolistic cash cow franchise, strong competitors and several fledgling multi-billion dollar upstart business to do with its excess earnings? Invest them deeply into new businesses and ventures for future value creation, or retain them as excess cash to sit on a balance sheet which already has in excess of $30 billion of unencumbered cash in it?"

As a reminder to our paying subscribers, on November 2010 we downgraded the stock to Neutral from our Overweight stance while maintaining our valuation. Given the market’s reaction to the stock and the fact that growth was ahead of our expectations, we upgrade the stock back to Overweight territory. The full, unabridged quarterly review is available to all paying subscribers here: File Icon Google Q1 2011 results.

Next up will be a dissection of Apple's explosive growth. If you have read my mobile computing wars series, you know that I believe this is a 3 three horse contest and thus far not much has changed in regards to whom those horses are and who is the front runner.

Last modified on Thursday, 28 April 2011 12:26


Login to post comments