Friday, July 22, 2005

Google Stock Sinks on Slow Revenue Growth

I live in the Silicon Valley--home of stock option wishes and tech start-up dreams. I saw this story off the Associate Press:

SAN FRANCISCO (July 22) - Google Inc. shares continued to tumble Friday amid disappointment over slowed revenue growth at the online search engine leader even as second-quarter profit more than quadrupled.

Shares of Google fell $15.96, or 5.1 percent, to $297.98 in afternoon trading on the Nasdaq Stock Market, a day after the Mountain View-based company reported earnings climbed to $342.8 million, or $1.19 per share, from $79.1 million, or 30 cents per share, at the same time last year.

If not for a charge to account for employee stock options issued before Google went public 11 months ago, the earnings would have ranged between $1.29 and $1.35 per share. That topped the mean estimate of $1.21 per share among analysts surveyed by Thomson Financial.

Revenue for the period totaled $1.38 billion, nearly doubling from $700.2 million last year. After subtracting the commissions that Google paid to other Web sites in its advertising network, the revenue stood at $890 million, beating the Wall Street estimate of $842 million, according to Thomson Financial.

Reflecting investor anticipation of a big quarter, Google's shares reached a new high of $317.80 on Thursday before retreating slightly to finish at $313.94, up $1.94 for the day. But then the shares dropped in extended trading.


The biggest problem with Google now is that they haven't learned how to grow up. Google is no longer a tech start-up company. Google is a mature technology company and they have to adapt their business model to reflect that maturity. That is not a bad adaptation--Yahoo, Microsoft, and Intel are excellent examples of mature technology companies. Unfortunately, everyone here in the Silicon Valley still believes in "Google: The Start-Up Dream Machine." Its stock is so closely watched here. Consider the following the AP story:

Google's stock also had become overheated in anticipation of a blowout quarter, said Piper Jaffray analyst Safa Rashtchy. ''The stock had been going up too much in the last few days. It was becoming too much about a game of momentum. This quarter looked fine to me. There was nothing that surprised me about the quarter or the way investors reacted to it.''

Although Google's earnings and revenue continue to rise at a rapid clip, some of the gains weren't quite as large as in recent quarters - something that often happens as companies get bigger and the comparisons become tougher. For instance, in the first quarter, Google's earnings surged to a more than sixfold improvement.

In another development that may have troubled investors, Google's second-quarter revenue rose by 10 percent from the previous quarter. The sequential revenue growth had ranged between 15 percent and 28 percent in the previous three quarters that Google had reported as a publicly held company.

But the second quarter typically marks a financial slowdown for many Internet companies that rely on heavy traffic like Google, because more people are spending time away from their computers as the weather becomes warmer and the days grow longer. The same dynamic seemed to affect Google's second quarter results last year, when revenue increased just 7 percent from the preceding quarter.

Industry analysts believe the seasonal shift is one of the reasons that another Internet bellwether, Yahoo Inc., merely matched analysts' expectations in its second quarter, a performance that caused its stock to plummet earlier this week.


As a mature company, you cannot expect to get 28 percent growth rates per quarter indefinitely. You cannot expect to see your stock going up to $300 a share, then $350, or $400 a share. The stock is going to get too expensive--pricewise--so that individual investors are not going to buy into it. The problem here is that Google founders Larry Page and Sergey Brin want to have it both ways. They want to covet the bounty of investment dollars by making Google a public company, however they refuse to relinquish control of their company to professional management. If Google is unable to consistently produce those extraordinary earnings growth marks, then investors are going to balk at investing their dollars in Google's extraordinarily high stock price. Once that happens, there's only one direction for Google's stock.

4 comments:

--H said...

Eric:

I'll be nitpicking on this statement of yours:
The biggest problem with Google now is that they haven't learned how to grow up.

I think the biggest problem does not lie with Google but with (ignorant) investors and the always ga-ga research analysts. They are the one who set up the "standard" of Google having to keep growing at "x-level" clip or higher without realizing as companies mature it's (almost) an impossible feat.

Unfortunately, those (ignorant) investors just can't learn from the past dotcom bubble. Research analysts have nothing to lose by trumpetting companies - worse come to worse, they can "pursue other opportunities" or "join a hedge fund" after bagging their millions - but (ignorant) investors who believe that a stock like Google can only go up is not much different than speculative property investors.

That is not the same like my saying Google is a bad company, on the contrary, I think it is an excellent organization. It's just that from a financial perspective, there is no way for me to justify its "market value" of 150+ P/E ratio.

Eric A Hopp said...

How about we split the difference on my statement?

I will admit that I'm not thrilled about ignorant investors, ga-ga research analysts and the Wall Street cheerleaders demanding that Google concentrate on short-term quarterly improvements at the expense of long-term growth. But at the same time, I'm not too partial to Page and Brin's desire to maintain total control of Google through their control of preferred stock holdings--giving them ten votes per share of stock, over the one vote per share of common stock. I know that Sergey and Page created this maze of stock classes so they can control the company and concentrate on the long-term growth, but it smells fishy. I guess I just don't like the idea of both sides--Wall Street and the company founders--not trusting each other regarding Google's future as a company.

If I'm a shareholder in a company, I want that company to be profitable, and grow. I want that company to look towards the long term growth, rather than short-term profits. But at the same time, I don't want the founders of the company to abuse their power at the expense of my trust in their judgement. I've seen too many CEOs use their power to excessivly profit for themselves at the expense of shareholders--Enron, Tyco, Adelphia, Healthsouth, Worldcom. I want a balance in providing a CEO of a company with the power and rewards towards long-term growth and profitability, but with the responsibility and check against any potential abuse of power that CEO may try to use.

You are right about the fact that there is no justification for Google's P/E ratio for being at 150 with and EPS of $2.53 (I currently checked the Yahoo finance, and Google's P/E was listed at 119) Of course, Google only has 277 million shares in the market. Google's closest competitor Yahoo has a P/E ratio of 39, with an EPS of $1.08. Then again, Yahoo only has 1.4 billion shares in the market to pay its profits out to. So it is all relative--do you want to buy an expensive share of Google stock, which pays a greater portion of its profits out towards a smaller number of shares, or buy an inexpensive share of Yahoo stock, which pays a smaller portion of its profits towards a larger number of shares.

Then again, has Google even paid a dividend out to its shareholders?

--H said...

Actually, we're not that much different, I was just being nitpicky ... ;o)

As a proponent of free-market, I too am not crazy about the difference in class of stocks issued by a company.

Like you said, Page and Brin don't seem to trust Wall Street. With that said, if I'm a betting man, my money will be on Page and Brin for the more "trustworthy" (for whatever it's worth) between the 2 sides.

For example, I like the way Google is not giving out quarterly earnings guidance to the Street. My previous job related a lot to this so I'm ready to discuss/debate about the merit of NOT issuing the shortsighted quarterly earnings guidance.

On the EPS and P/E, what you saw in Yahoo is almost always "meaningless' since those are not "normalized" EPS (but GAAP/Accounting EPS), thus not reflecting the "true" P/Es of any company. Plus, in the case of both Yahoo and Google, the EPS would further be hit by the stock option grants that are still not expensed. As recent as couple quarters ago, Yahoo's positive EPS would have been negative (much higher negative number compared to the reported positive EPS) had the option grants been expensed (as I think they should).

Both are still cool companies, but are not the type of companies that I think should maintain NOT expensing stock options (I believe only start-ups should be allowed NOT to expense their options).

So at the end of the day, who knows what the 39x or 115x or 150x P/E ratio would mean?

Again, I really admire Google as a company but at this price, somebody needs to shoot me on the head before I'm willing to pay for its share.

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