Ex-Merril Lynch Internet analyst Henry Blodget (pictured left) outlines the bear case on Google, "laying out a scenario that could kneecap Google and take its stock back to, say, $100 a share". He asserts that there's a risk of flattening keyword pricing (which I argued against only yesterday) and revenue compression from click fraud. The most thought provoking section, however, is his analysis of Google's cost structure:
"The one drawback of super-high-margin revenue streams is that they create the illusion of endless and effortless profitability. Google has so much money right now that one of its biggest challenges is finding ways to spend it ($200 million on Googleplexes, $600 million on server farms, $500 million worth of product development per year). What this translates to is a high and rapidly increasing fixed cost base--one that, on the income statement alone, now amounts to a run-rate of about $2 billion a year (excluding traffic acquisition costs).
Importantly, almost all of this $2 billion is fixed, not variable. If revenue drops, these expenses will remain the same--unless Google takes painful steps to cut them."
It's interesting to note that heavy fixed costs could haunt Google even without a decline in its advertising revenue. It's now widely known that Google has ambitious telecom plans, and those will almost certainly lead to lower margins. It's not clear how investors will react.
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