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January 26, 2011

Google Brings Good Earnings But Uncertainty Prevails. For Now.

Despite another strong earnings report, Wall Street is worried about the implications of Google's management change. Is it a sign that things are not as good as earnings make them appear?

It has been an interesting several trading days in Google (GGOG) shares. After the close on Thursday, January 20th, GOOG reported very good 4Q10 earnings. EPS easily exceeded expectations on much better than expected revenue growth. The top line benefited from rising searches, rising revenue per search, and continued growth in new growth initiatives in display advertising, mobile advertising, and YouTube. While coming in way ahead of street expectations, EPS growth would have been even higher if not for another quarter of heavy investment as GOOG seeks to sustain its lead in search and build display, mobile, and YouTube into material, new growth drivers.

When the results were first reported, GOOG shares soared about 4%. Investors have finally become comfortable rewarding GOOG for top line growth even if it comes with a price of higher operating expenses. The gains did not last long, however, as GOOG simultaneously announced a major shuffle of its top management. Eric Schmidt, long time CEO, was moved out of his operating responsibilities and replaced by Google co-founder, Larry Page. Schmidt, Page, and Sergey Brin, Google's other co-founder, came on the quarterly earnings conference call to reassure investors, but GOOG shares quickly reversed, giving up most of their gains.

Several things seemed to worry the street about the management change. First, Schmidt is well thought of and despite being at Google for 15 years is still viewed as a bit of an outsider, offering mentoring and positive influence to a company still dominated by its founders. Wall Street has liked Schmidt being a check on the founders. Second, Larry Paige, while acknowledged as a visionary, is not thought of us an operating manager. Furthermore, his strengths do not align with a CEO's typical role as the face of the company, particularly to Wall Street investors. Finally, the need to shuffle top management was interpreted as a sign that Google's competitive positioning and growth outlook might not be as strong a recent string of positive earnings reports suggest. Facebook and social media and Google's lack of success in its own social media initiatives are a worry that had been put on the back burner as search growth reaccelerated and new initiatives kicked in. Now Wall Street is asking whether the management change is sign of weakness?

Friday morning saw most Wall Street analysts defend GOOG and reiterate their buys while raising their target prices. This did little good as the shares were being sold and down from prices immediately before the earnings report. The stock really plunged in final half hour of Friday trading when it was announced that Schmidt would be selling 6% of his GOOG shares over the course of 2011. Selling continued into Monday morning with a low of about $600, a full 4% or $25 below the pre-earnings/management change announcements. The stock had sold off about 8% from its high immediately after the earnings were reported. Over the past 24 hours, the stock has begun to find its footing and regained about 3% but it still sits below its pre-earnings level.

I provide this recap mainly to educate Media Talk readers about the crazy ways of Wall Street, particularly in regard to short-term trading. Perception often drives trading and earnings are often discounted ahead of the actual report. In this case, we have a company that based on its most recent quarterly results is stronger than expected but uncertainty has been introduced via the management change.

I continue to have great confidence in Google's earnings and growth outlook and feel the stock offers a lot of bang for the buck. A P-E of 15 adjusted for massive and growing cash balance seems like a good deal for a leading growth stock that has the potential to sustain EPS growth of 15-20% for the foreseeable future. I concur with analyst targets of $700 plus and will continue to hold Google shares in Northlake client accounts, the Entermedia hedge funds, and my personal accounts.

Disclosure: Google is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. Google is a net long position in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia's investment management company, and has personal monies invested in the Funds.

Posted by Steve Birenberg at January 26, 2011 11:20 AM in GOOG