Google (GOOG) introduced plans for a stock split in its latest earnings report. Ordinarily good news, this split has investors concerned and confused as it would create a new class of non-voting shares that would be listed under a different ticker symbol than existing stock.
Since the three founders of Google retain a majority vote and are in favor of this measure, I expect it to pass, though Google will be hosting a shareholder meeting pursuant to its legal obligations as a corporation. The stock split would give the Google co-founders even greater control over the company's direction. Google's stock has been tracking steadily lower since the announcement, falling from around $651 on April 12 to its current price around $608.
Also in its earnings report, Google revealed problems with its ad auctions that are eroding ad revenues. The root cause of the problem has not yet been identified, but though the number of paid clicks increased by 39% quarter over quarter, Google's ad revenue decreased by 12% by the same measure. In comparison, Microsoft's (MSFT) advertising revenue through Bing grew by 13%. Microsoft attributes the improved results to an increase in Bing's market share, now standing at 15.1%. If this continues, it would spell trouble for Google's stock price and good news for Microsoft's.
Google's overall revenues did increase year over year, from $8.58 billion to $10.65 billion, or 24%. Though this posted as a win in Google's playbook, uncertainty over the cause and duration of the ad revenue problem, coupled with the upcoming stock split and persistent legal challenges, have pushed the stock into a meandering slide.
Regulatory and Legal Challenges
Recently, Google was fined $25,000 by the Federal Communications Commission for hampering an investigation into data collection efforts for Google Street View. On the heels of this, the Federal Trade Commission is investigating allegations that Google deliberately coded around privacy controls on mobile phones using Apple's Safari browser. The fines from the FTC could be heavier than those from the FCC - except to Google, where heavy is measured in the billions of dollars; it is possible for the FTC to levy fines this high, but exceedingly unlikely. The FTC's action is related to a settlement agreement in 2011 with Google over Google Buzz, and the maximum penalty is $16,000 per user per day. However, it would be next to impossible to determine how many users were affected by this practice and whether each user experienced a privacy violation on a daily basis, so in my opinion, it is much more likely that Google will negotiate to settle the case.
Google is also defending itself against allegations that it developed its Android software with Java programming without permission from Oracle (ORCL), which owns the Java platform. If the jury finds in favor of Oracle, Google would be able to continue using the current programming by paying licensing fees (and potentially, a settlement) to Oracle. This alone is not enough to move Google's stock, though it would move Oracle's. The potential for increased new growth on an existing product as companies pay royalties to avoid lawsuits would push Oracle stock upwards.
And again on the legal front, recently Australian Federal Court judges found Google responsible for preventing sponsored ads that are misleading to consumers. Google currently does minimal policing of keyword usage by its ad sponsors. For example, users searching for 'Hotel Company A' may receive sponsored search results for 'Hotel Company B', if Hotel Company B bought an ad using its competitor's name as a keyword. The verdict, if not overturned on appeal, would force Google to go beyond abiding by its stated policies to actively monitor and prevent incorrect usage of search terms by purchasers.
The Australian case threatens Google's core business, as 80% of the tech giant's revenue comes from search. For fundamental investors, this leads to the biggest question of all. How will Google's moral culpability for internet behavior through its services affect the stock price?
Google's motto, "do no evil", is front and center, as stockholders and users wonder exactly what that motto means to a company that has dominated market share in so many areas and is positioned to expand even further.
Co-founder Sergey Brin regularly discusses fears of the loss of internet freedom and attacks the "walled gardens" of Facebook and Apple (AAPL), whose content is largely protected from Google's search algorithms. At the same time, Google itself tightly controls content, burying sites it deems as "gaming the system". But isn't that what Google does? It games its system to deliver the most search results by market share in markets across the world, according to who is paying it the most ,even as it complains over access and control of information by governments and its competitors.
I think that this, more than anything else, may lead the way to a lower Google stock price in the very long term. If Google is seen as flexing its muscle to keep down the competition, or at least throw hurdles at the competition it can't keep down, the motto "do no evil" will do no good. Google Plus and its non-using user base is proof that Google cannot move public opinion as it pleases over the long term, and a declining user base across multiple platforms could eventually shatter the company.
Looking at Google in comparison to four of its competitors and peers, it's clear that Google's moat is too narrow to justify its forward price to earnings expectations for long, and the items discussed above are enough to cast doubt on its ability to continue trading at $600 plus per share for the long term.
Google is currently trading at around $610 per share with a forward price to earnings ratio of 12.1. Microsoft is comparatively cheaper, currently trading around $44 with a forward price to earnings ratio of 10.4. Microsoft will release its next quarterly earnings report on April 19; it may announce greater search capture for Bing, which would put further downward pressure on Google's stock price.
Apple is trading around $610 with a forward price to earnings of 12.1, the same as Google. Apple's divisions that compete directly with Google, namely its application, cloud networking, and mobile device arms, increased sales between 7% (for applications) and 128% (for iDevices) year over year, indicating that Apple is more than ready to compete with Google for dominance, particularly in mobile as Google's Android is not even close to posting 100%-plus adoption numbers.
Oracle, Google's courtroom rival, is currently trading around $30 per share with a forward price to earnings of 11.1. In its most recent quarterly report, released on March 20, Oracle reported earnings per share of $0.49 on increased revenues that were up 3%. Like Google, Oracle is sitting on the wealth of a small sovereign nation, with $29.7 billion in cash, equivalents, and liquid securities, and represents yet another party in Google's peer group that can compete on Google's terms.
Lastly, Hewlett-Packard (HPQ) is currently trading around $25 per share with a forward price to earnings of 5.6. Hewlett-Packard is competing with Google primarily in cloud storage and is coming in extremely cheap for a reliable tech stock with a dividend (1.9%), but it is not faring so well. Hewlett-Packard's latest quarterly earnings report on February 22nd revealed that it experienced a 10% decline in enterprise and storage solutions revenue, though networking remained flat. This makes it less of a competitor for Google for the near term, though from Hewlett-Packard's numbers, I can see that its networking clients are not jumping ship for Google, either.
I think that given its recent legal and regulatory issues, the stock split that isn't even a veiled attempt at power consolidation and competitor agility; Google is currently overvalued for all but short term trades. Its cheaper competitors have more room to grow and fewer negative headlines, so I would be careful with Google in the near term while there are other options.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.