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July 23, 2013

Google Core Trends Intact Despite Noisy Quarter

Google (GOOG) reported slightly disappointing second quarter earnings. Revenue of $11.1 billion was slightly less than estimates of $11.4 billion. EPS of $9.54 were materially below consensus expectations of $10.81. Given these headline numbers, GOOG shares initially traded down about 5%. However, they were down less than 2% when trading closed the day after the report and have since recovered all the lost ground.

The margin contraction was a little worse than the headlines suggested as GOOG accelerated deprecation that may have cost the company close to 50 cents a share. Other key items below the headlines include still very strong growth in searches (clicks up 23%) and ongoing pressure on search prices as more searches are on lower priced mobile platforms or in emerging markets. There is great hope that pricing improves as GOOG continues to rollout its “enhanced campaigns” that combine a mobile and desktop ad buy. Motorola continues to perform horribly and lose money but a high end phone is due to be introduced in October.

I don’t see anything that changes the core fundamental story at GOOG. Revenues continue to grow about 20% with EPS growing slightly slower as GOOG spends to defend its core search business and expand into new areas. Profit margins are the primary risk for the shares as management is content to focus on absolute profit dollars rather than margins. Given that search is always going to be the company’s highest most profitable business, margins will come down. I believe that this expectation is built into the stock which trades at a reasonable 15 times 2013 earnings adjusting for over $130 in cash on the balance sheet. In a market where most companies are growth-challenged, GOOG seems like a logical place for investors to allocate money. In fact, I think this is largely why the stock bounced back after the disappointing earnings. The reality is that GOOG still offers attractive growth at a reasonable price.

I have long held to a $925 target on GOOG based on 2013 estimates. As we look forward to 2014 and EPS over $50, I think the shares can work to over $1,000. This is not huge upside, just 10-15%. But with the market at all-time highs and most companies struggling to generate even mid-single digit revenue growth, I think GOOG’s relative attractiveness remains high. After the move up from the mid-$600s, GOOG shares are no longer a screaming buy but offer enough upside to warrant maintaining as a core position in Northlake client portfolios.

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 positions 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.

Google (GOOG) reported slightly disappointing second quarter earnings. Revenue of $11.1 billion was slightly less than estimates of $11.4 billion. EPS of $9.54 were materially below consensus expectations of $10.81. Given these headline numbers, GOOG shares initially traded down about 5%. However, they were down less than 2% when trading closed the day after the report and have since recovered all the lost ground.

The margin contraction was a little worse than the headlines suggested as GOOG accelerated deprecation that may have cost the company close to 50 cents a share. Other key items below the headlines include still very strong growth in searches (clicks up 23%) and ongoing pressure on search prices as more searches are on lower priced mobile platforms or in emerging markets. There is great hope that pricing improves as GOOG continues to rollout its “enhanced campaigns” that combine a mobile and desktop ad buy. Motorola continues to perform horribly and lose money but a high end phone is due to be introduced in October.

I don’t see anything that changes the core fundamental story at GOOG. Revenues continue to grow about 20% with EPS growing slightly slower as GOOG spends to defend its core search business and expand into new areas. Profit margins are the primary risk for the shares as management is content to focus on absolute profit dollars rather than margins. Given that search is always going to be the company’s highest most profitable business, margins will come down. I believe that this expectation is built into the stock which trades at a reasonable 15 times 2013 earnings adjusting for over $130 in cash on the balance sheet. In a market where most companies are growth-challenged, GOOG seems like a logical place for investors to allocate money. In fact, I think this is largely why the stock bounced back after the disappointing earnings. The reality is that GOOG still offers attractive growth at a reasonable price.

I have long held to a $925 target on GOOG based on 2013 estimates. As we look forward to 2014 and EPS over $50, I think the shares can work to over $1,000. This is not huge upside, just 10-15%. But with the market at all-time highs and most companies struggling to generate even mid-single digit revenue growth, I think GOOG’s relative attractiveness remains high. After the move up from the mid-$600s, GOOG shares are no longer a screaming buy but offer enough upside to warrant maintaining as a core position in Northlake client portfolios.

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 positions 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 July 23, 2013 11:45 AM in GOOG