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April 24, 2013

Another Solid Quarter From Google Supports Bull Case

Google reported solid first quarter 2013 earnings with most important financial and product metrics tracking very close to expectations. With the stock off 10% from its 2013 and all-time high going into the report, the results were good enough to relieve the pressure. The shares are now up 7% off their April lows but remain about 3% below the all-time high from early March.

I continue to believe that the fourth quarter results, reported in January, marked an important turning point in investor sentiment toward the shares. Investors now see Google as benefiting from the trend toward mobile broadband (smartphones and tablets). In turn, this raises confidence that the company can sustain revenue and EPS growth near 20% a year. With that kind of growth, the shares remain inexpensive. Upside remains over $900 based on a P-E ratio of 15 times 2014 estimated earnings of $54 plus the company’s large cash balance that is contributing virtually no interest income.

Google reported revenue growth of 23% excluding the impact of foreign currency fluctuation. EPS were flat after adjusting for a lower tax rate due to dilution from the Motorola acquisition. Motorola should cease to be a problem later this year as Google finishes restructuring it and losses abate. Paid search growth decelerated slightly but remained at 20%. Cost per click (the price Google receives for a search ad) fell 4%, but the trend remains positive as last quarter was -6% and last year pricing was down double digits. As noted, each of these items was inline with Wall Steer expectations and a continuation of trends evident in the fourth quarter of 2012.

Beyond the risk to search market share and search pricing in a predominately mobile environment, the next big risk to Google is that its profit margins will come under pressure as it invests to secure its long-term growth rate. On this front, the last couple of quarters provide some confidence for bulls. Expenses are rising rapidly as the company builds out infrastructure and pays for traffic to its search engine. However, expense thus far appears manageable. Furthermore, the company is starting to gain respect as an innovator for Google glasses and self-driving cars and Google fiber (cable TV and broadband services). Thus, investors are a little less worried about expense growth on these types of projects.

Looking forward, investors will remain focused on the trade-off between the number of searches and the price received for each search. Trends here seem be stabilizing with search growth still strong, though off its highs, and search pricing down but firming up. Google is implementing new search advertising campaigns that could improve pricing on mobile searches. A positive turn in mobile search pricing over the balance of 2013 is the biggest catalyst for the shares.

Google is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. Google is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Posted by Steve Birenberg at April 24, 2013 09:53 AM in GOOG