Bullish on Google: Consistent Growth, Deserving of a High Premium

Brian Bolan, research analyst at Jackson Securities, sent a note to his clients on Google's (GOOG) Q107 earnings. Key excerpts follow:

After the close, Google reported earnings of $3.68 per share beating our earnings estimate of $3.52 and the consensus estimate of $3.30. Net revenues of $2.534B were above our $2.515B estimate. We should note that our estimate is among the most aggressive on Wall Street.

Core Search drives the success

The core search business continues to be the source of the success for Google, as more traffic turned into more clicks and more cash for investors. It was noted on the conference call that the success of the core search business has enabled the company to expand into several areas that it otherwise may not have been able to address. These areas include the applications division, which is seeing success in its own right.

We believe that the core search business will continue to achieve superior financial results and will keep the company on a growth trajectory on or above the current markets rate.

Market Share

Prior to the release of earnings, third party data suggested that Google holds around 48% of the market. We believe that this number will increase dramatically over the remainder of the year about could approach 60% by the end of the year.

Taxes…. Yet again a source for the out performance

The tax rate for the quarter, after certain adjustments came in at 25.9%, well below our estimate of 29.5% which we used after the company noted that they were targeting a 30% rate for the year. Once again, Google’s creative and effective application of tax codes drove the out performance. Again it appears that the tax rate that we have for the remainder of the year is too high and we plan on adjusting it later in the quarter. We will target a tax rate of about 25% for the company for the year.

This adjustment to the tax rate will likely drive our earnings estimates higher, but we doubt that change will lead to a change in target price as it more of a financial side step than an operational benefit to owners. That is not to say that the lower tax rate is not appreciated by owners, it most certainly is.

Key Takeaway

Our enthusiasm for Google might be tempered a bit as we continue to bang our heads against the wall in terms of the tax rate. We are not faulting the company for attempting minimize its tax pay-out, but if we had assumed a tax rate of 24% instead of the 29.5%, we would have hit the earnings number on the head.

Looking ahead

We might as well stop listening to the Yahoo! (YHOO) call for an idea of what Google will do, as the competition may really begin to see a large separation. As we start what is traditionally the slower season for internet companies (due in part to better weather and summer vacations) we believe that we could see the market share numbers move in a substantial way. With Microsoft becoming more and more of a non-factor in the search business, it could be only a mater of time before they sell off those assets to a competitor or attempt to redirect them entirely.

TAC

TAC or traffic acquisition cost, continues to rise. This quarter saw a dramatic increase to 84% of Network revenues. This implies that the revenue sharing deals with larger publishers are beginning to meaningfully increase. Even as the TAC number rises, and when we update our model we will certainly be moving our TAC estimate to the mid 80’s and by the end of the year it could reach 90%.

We are not overly concerned about TAC, as large deals likely carry revenue share agreements that are in the mid 90% range, but it points to what is a larger problem. The business is more and more coming from the largest of advertisers who are more likely to switch providers when their needs aren’t met. At this time, there is little if any anecdotal evidence or even a suggestion of this happening. It is however a concern, and something we will track over the coming quarters.

Valuation

Our target of $560 per share and buy rating suggest that we are bullish on the stock. We believe that a multiple of earnings is the best way to value almost any company, and a consistent grower such as Google is deserving of a high premium.

In the coming weeks we will more deeply address the idea of valuation of Google and Yahoo! as well look at the surrounding issues such as market share, product development and effectiveness ratios (CTR’s etc).

Comments

[Sr. Pessimist:]

Ads and search are a two-trick pony. I don't believe in two-trick ponies for the same reason I don't believe in Microsoft.

2007 Apr 20 11:02 AM