Google's Numbers Continue to Improve, Beating Even Aggressive Estimates (GOOG)

Brian Bolan, research analyst at Jackson Securities, sent a note to clients on Google's (GOOG) most recent quarter. His note follows:

Summary
After what was a very impressive quarter, the Google conference call was only lightly sprinkled with other tidbits of information that investors could use. We picked up on a few key ideas and subsequently updated our model to reflect those ideas (using cash and not stock for acquisitions in the future and the tax rate) but little else of value was divulged on the call.

Earnings
After the close Thursday, Google reported earnings of $2.62 per share beating our earnings estimate of $2.57 and the consensus estimate of $2.41. Net revenues of $1.86B just below our $1.88B estimate. We should note that our estimates were among the most aggressive on the Street.

The first big acquisition, YouTube
During the quarter, Google agreed to purchase YouTube for $1.65B in stock. This was the first large scale acquisition that the company has attempted and comes with stock as opposed to cash even as the company is sitting on a war chest of nearly $10B in cash. On the conference call, management noted that this deal done as a stock transaction is to be considered a one time instance and future deals would be done in cash.

YouTube is the number one video site on the web and it has experienced tremendous growth over the past few quarters. When questioned when YouTube would be profitable, management responded with the customary “we don’t give guidance.”

Market Share
Google gave us a little more insight into the market share questions that have been around for the last few months. Independent third parties have shown over the summer months that Yahoo (YHOO) had gained share on the search leader Google. On the conference call it was noted that Google has a high amount of academic searches, which was the reason for the lower search numbers in the summer and the quick rebound of late.

Taxes….and death
The tax rate for the quarter came in at 29.5%, in line with our estimate. The company also noted that they would be at or below the 30% rate for the year. This holds true from the previous quarter and gives us an idea that the effective tax rate for the fourth quarter will be in the same ball park.

We have moved our effective tax rate for the fourth quarter up to 33% as a result of the tax rates in the previous quarters. That would bring the average effective tax rate up to 29.2% for the year, and could also serve to dampen what could be a strong 4th quarter.

Key Takeaway:
One of the main takeaways from the conference call has to be that Google consistently answered questions with the idea that they are building on prior improvements. Another term that came up a few times was a cascading effect that they are witnessing. Clearly these are two very positive attributes for any company to exhibit, but for a company that is closely guarded as Google, it's even more impressive.

CapEx… Where the millions are headed
Little in the way of information was given on where the CapEx dollars are being spent, but we did find out that the company plans to continue its aggressive hiring patterns. Outside of the conference call, the company noted that it plans to install solar panels to help offset the huge power demand the company possess due to the large number of computers and other devices its runs.

TAC and the confusion on the call
On the conference call in the prepared slides, the company states that TAC is headed the right way. The slides have TAC as about 30% of total revenues. We however prefer to look at the TAC number only against the Network revenues as in the owned sites Google will generally keep the vast majority of the ad revenue.

Our calculation shows TAC climbing once again. This quarter the TAC rate reached 79.6%, up from 78..8% in the previous quarter and 77.9% in the first quarter. We have adjust our estimates to reflect this trend and have an 80% rate on the network side for 4Q06 and CY07.

Valuation
We were well above the street estimate of $2.42, a full $0.17 ahead and Google still was able to beat our bottom line estimate. The topline however came in just shy, but again, we were very aggressive with our estimate. We note that we are still very aggressive with our estimates, especially considering all the changes we have made to CY07’s numbers. We have tinkered quite a bit with next quarters estimate, but it is still holding at $3.03 on the bottom line and much of the tinkering is adjustments to the model and not the thesis of the investment in the stock.

We are maintaining our current target price of $500 per share even as the stock moved as higher than $458 in the after hours market. We expect to give another Google update in Mid November, at which time we will likely be raising our target price due to the estimates we have for CY07.

GOOG 1-yr chart:

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Comments

[Sufiy:]

Lets keep all media hype away and quick short covering amusement following it and check out Google's development in recent Q in order to try to understand its valuation compare to its piers. Upside now is known and everybody is on Buy side with price target 600 (+30%). Shorts are killed and short ratio is less than one day trade, no easy money for upside after yestoday short covering left, somebody has to start to buy into this story at this 460 level. First Google came with Rev 2.69 billion which is less then 2.76 which I have projected from PWC predictions of 16-18 billion online ads market in 2006 with Google Share of 40.5% of this market in Q3 (seasonal trend applied) So, first Google did not manage to increase its market share in Q3. Second, lets look at earnings GAAP ($) Q1 1.95, Q2 2.33 (+19%), Q3 2.36 (+1.3%!?) Earnings growth dramatically slowed. Third, revenues: Q1 2.25, Q2 2.46 (+9.3%), Q3 2.69 (+9.3%!?) math's precision or can I smell some cooking oil here? 44% of revenue is coming from international business. All hitfarms are located in pure "international "destinations India, China, Malaysia, Russia etc. Revenue growth is slowing with increased risk of cutting back on advertisement due to economy slowdown and click fraud awareness buy the customers. Fourth, Net cash from operations Q1 0.825 (37% of Rev), Q2 0.841 (+2% 34% of Rev), Q3 1.0 (+19% 37% of Rev) Capex Q2 0.699 (0.319 Real eastate 0.380 "normalised"), Q3 0.492 (+29%!) So Google Capex increase is really much bigger then their Rev growth 29% vs 9.3% with constant Net cash from operations at 37% Rev, Free Cash Flow is under compression. Total Free Cash Flow for nine months is 1.112. If we will project Rev growth for Google at 12% for Q4 vs 9.3% for Q3 they will make Rev Q4 3.0 (less then based on PWC and 41% of market 3.2) Net cash from operations at 37% of Rev 3.0 will be 1.1, if we apply 20% growth for NCFO in Q4 (vs +19% Q3) we will get 1.2 so lets assume NCFO will be in the middle = 1.15. What about Capex? I think it will be increasing dramatically with moving into video: broadband, storage, new blades, electricity. But if we even aply same growth to capex as to Rev +12% (they said it will be bigger then Rev growth, Q3 was +29%) Capex Q4 will be 0.551. So, Free Cash Flow in Q4 will be NCFO-CAPEX=0.6 and total FCF 2006 will be 1.712 If stock will not move from 460 we have MC=142 billion MC/FCF=83! YHOO is projecting FCF 1.35 in 2006 (lowered recently) with MC at 32 their ratio is MC/FCF=24 If the Google will manage to make even 2.8 EPS in Q4 (+19%) (do not forget annual charge for all those "to be expenced option related expences which they did not account in past Qs) GAAP 2006 will be 9.44. So with GOOG at 460 we have company with 2006 est MC/FCF=83, P/E=48.7, P/S=14.2 with slowing growth in EPS and Revenue and most important with dramatic compression in FCF. YouTube will bring dilution, much more CAPEX in Video Game and No revenue so far. What is the more reasonable valuation of Google: if we give GOOG MC/FCF=40 (69% over YHOO for leadership and "strength") MC with 1.712 FCF must be 68.5 billion with 310 million shares outstanding before YouTube diluton it is...221 share price. When MR Market will figure it out I do not know, but I am testing the water with March 2007 460 puts.
sufiy.blogspot.com/

2006 Oct 22 09:54 AM

[Sufiy:]

Few more observations on recent trends in Revenue and Net Margin of google presented in CC slides
investor.google.com/pd...
First of all I dare to say that they have monetised everything from the existing traffic with diminishing growth and they are desperate to buy new traffic in order to monetise it. The biggest problem here that YouTube traffic is not monetisable straight forward if meaningfully monetisable at all. But few figures: Growth in Google.com is in the slowing trend Q3/05 +20%; Q4/05 +24%; Q1/06 +18%; Q2/06 +10.4%; Q3/06 +13.5%. Share of Network Revenue is declining Q2/05 85%; Q3/05 76.3%; Q4/05 72.8%; Q1/06 71.5%; Q2/06 69.6%; Q3/06 63.8% and growth in Network revenue is slowing even more aggressively: Q3/05 +7%; Q4/05 +18%; Q1/06 +16%; Q2/06 +7.4%; Q3/06 +4% (!) What has happen? Partners has figured out how to monetise traffic without Google? Nobody is growing apart from Google (which is slowing down itself)? Click fraud with better audit available to advertisers is taking its cut from "partners" clicks? We can only speculate here, but trend is established and it must be very disturbing to Google management. Cost of this Network traffic is increasing, if you will proper apply TAC to share of Network Revenue you can see following picture: TAC/NetwRev Q2/05 78.4%; Q3/05 60%; Q4/05 78.7%; Q1/06 77.9%; Q2/06 78.7%; Q3/06 79.6%. So total picture is that growth of Revenue on Google.com is slowing to 12-15%; Growth of Network Revenue is slowing dramatically to single digit figures and its cost TAC pushing 80%. Net Network Revenue was Q1/06 205 mil 15.8% of Rev Google.com; Q2/06 212 mil 14.8%; Q3/06 212 mil (!) 13%. Somebody is playing math here? Do you remember how insurance companies like AIG smoothed their earning with "Partner Deals"? Traffic exchange even more easy to regulate or maybe some of the "Partners" in the "Network" in the Family. But no offence Boys - you are hardly pushing any Law here and clear in your intentions: Selling your shares smooth and fast. All written above went straight into the money: Net margin contracted in Q3 vs Q2 from 29.4% to 27.3%. Should I send it to Google? Or they already has this slides for internal use?
sufiy.blogspot.com/

2006 Oct 22 12:46 PM