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Key points from JPMorgan Equity Research Analyst Joseph Okleberry's recent note clients on the expansion of Google's CPA ad program (for a full-length .pdf version of this report, click here):

Google (GOOG) announced Tuesday that it has expanded a beta test of a cost-per-action advertising model. See below for our takeaways:

Google Expands CPA-based Ad Test. Google has been testing CPA-based advertisements in its content network on a limited basis since June 2006, but plans to expand the test to additional US-based advertisers over the next few weeks.

Google May Quickly Become a Large Affiliate Marketer. Given Google’s expansive reach in the contextual ad market, and advertiser’s increasing preference for performance-based ad models, we believe the company could quickly become a significant affiliate partner for e-retailers and publishers. We believe the affiliate business is a natural extension for Google, and one which would help the company gain additional online ad share.

Advertising Expenditure as Cost of Revenue. Under the test, advertisers pay Google each time an action is completed on their website. Examples of such actions include clickthroughs, leads, page views, or purchases. Both the price and the action are determined by the advertisers, and as such we believe advertisers will have virtually unlimited demand for CPA-based referrals.

Success Could Lead to Rollout in Search Platform. If Google’s CPA model is successful, we believe the company would consider making it optional for search advertisers. Doing so would enable Google to help advertisers optimize conversion rates, which could in turn improve Google’s search monetization.

Valuation and Rating Analysis

We believe GOOG shares are fundamentally attractive due to secular industry growth trends, improving fundamentals in the international market, and expansion of new product categories such as contextual advertising and local search. On an EV/EBITDA basis, GOOG trades at 18.5x our F’07 EBITDA estimate of $6.9B, compared to its large cap Internet peers, which trade at 16.7x. Given that Google is growing significantly faster, we believe it deserves a premium. We reiterate our Overweight rating.

Risks to Our Rating

Google has experienced very fast revenue growth over the past few years. Our Overweight rating is based on the assumption that Google will continue to be the market leader in the paid search space and will continue to enjoy strong revenue growth. If the content publishers like Yahoo! and Microsoft are able to gain market share through user defection from Google’s user base, then our rating could be too optimistic. However, we have not seen any trends that would support this argument thus far.

Our Overweight rating is also predicated on the company’s success in the international market. If the company cannot successfully build out a larger international advertising base, the company will not be able to increase its monetization rate abroad. Additionally, as Google continues to expand its business internationally, it may face regulatory hurdles that make the business climate less hospitable and potentially less profitable than the markets in which it currently operates.

Source: Google CPA Ads Could Be Expanded To Search Platform