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October 18, 2012

Just When It Looked in the Clear, Google Misses

Google’s results and the negative stock price action are a good chance for me to reflect. In my Entermedia hedge fund, Google is the second largest long position. At Northlake, my long only registered investment advisor, Google is widely owned but a slightly below average position. As a generally long-term investor, my initial thought is today’s results are not a game changer. However, I can’t ignore the short-term either and that could be a little rough.

Standalone Google results were worse than expected. It’s not an excuse but it is worth remembering that Google provides minimal guidance. Let’s look at the estimates and reported figures for this quarter in the core Google (ex-Motorola). Google sites revenue was $7.73 billion vs. a consensus of $8.12, about a 5% miss but up 15% vs. a year ago. Google networks revenue was $3.13 billion vs. an estimate of $3.09 billion, about 1% ahead of expectations and up 21% vs. last year. Sites grew 2% sequentially with network up 5% sequentially. Google indicated that foreign exchange cost the company several hundred million dollars, a figure that is hard to compare to street estimates and hard for the street to calculate. Operating margins at the core were about 36%, approximately 1% less than expected and down 1% from a year ago. Paid clicks (volume of searches) rose 33% against an expectation of 34%. Cost per click (price of an ad) fell 15% against an estimate of down 11.3%. Clearly, there was an overall miss vs. Street expectations. Given that Google does not provide specific guidance, however, the miss seems within the margin of error. And not to be lost is the growth rate of the core business is still almost 20%.

One takeaway is that that Google’s lack of guidance results in more volatility of reported results relative to estimates than for most companies. More quarters than not over the last few years, analysts have been too optimistic. However, that does not mean that Google does not maintain a superior growth and investment profile for the long-term.

As noted, core growth this quarter was just under 20% and showed mid-single digit sequential growth. This is for a company that just reported almost $9 billion in quarterly net revenue, a $36 billion annual run rate. How many really large companies can grow anywhere near this rate? Google’s core search product is also being used more and more -- paid clicks up 33%. Sure, the transition to mobile means the cost per click or price of an ad is falling. Yet, it still nets out to stellar growth.

By any measure, Google appears to be gaining share and maintaining a very strong competitive position. It’s a position that is hard to attack. In mobile, you can argue that Google search is the only player. iOS and Android devices default to Google search. Bing and Yahoo are nowhere to be found in mobile.

Of course, momentum and short-term results matter on Wall Street. This quarter’s negative surprise, even if only modestly negative, is going to break the momentum the shares had finally gathered after a rough few years. Sentiment that had been improving is going to sour.

I suspect I’ll be looking to add to Google over the next days and weeks but it may be at lower prices than $687 (-9%) where it was halted after the earnings were accidentally released early. If the game hasn’t changed, Google can double its earnings in about four years. It seems to me that should lead to a much higher stock price eventually. How many large cap companies do you own or follow with that type of potential and with what appears to a very strong competitive position?

Google is widely held by clients of Northlake Capital Management, LLC, including in Steve’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov.Google and Yahoo are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, communications, and related technologies. 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 October 18, 2012 03:16 PM in GOOG