A few weeks ago, Google (GOOG) announced a stock split that took everyone by surprise. The split was designed to facilitate the continued control of founders Larry Page and Sergey Brin over the most dominant search engine in the world. In effect, investors are being asked to demonstrate confidence in their long-term vision for the company and their ability to implement that vision effectively. Google has a corporate structure that gives the founders majority voting control, and this has been copied by the newer generation of Internet companies such as Facebook (FB) and Zynga (ZNGA).
The stock split, however, takes this one step further to ensure that the voting control is not going to be diluted, even in the long term. In effect, Google's board of directors has approved the creation of new "Class C" stock, which is non-voting. With a 2:1 split, investors will get one share of the new Class C stock for each existing Google share. The price of the current Class A shares will split in half when the new Class C shares are issued and listed on the Nasdaq with a separate ticker symbol. The new class of stock could also be used for purposes such as stock options and currency for acquisitions so that there is no dilution in the control of Page and Brin.
The most notable developments in Google's past are the $12.5 billion acquisition of Motorola Mobility (MMI) and the launch of a social network Google+ to compete head on with Facebook. With enhanced competition on the Internet and the emergence of mobile devices and tablet computers, many people are trying to establish what this will mean for Google in the future. Google showed strong performance in the first quarter of 2012, with net income growing from $1.8 billion in the same quarter of the previous year to $2.89 billion last quarter. The EPS of $10.09 per share was in excess of the consensus estimate of $9.65 per share. However, investors are concerned about several issues. For one, the Motorola acquisition places Google in the hardware business, where it has no prior experience and where the operating margins are much lower than the margins of the existing business. There's also been a 12 % decline in online advertising rates in the first quarter, and this is the second consecutive quarterly decline.
While he did not comment on Motorola, Page emphasized that the company had been successful in making long-term bets that took years to succeed, and said that the only way to continue to capitalize on the big long-term picture was for investors to maintain their faith in the founders. As examples, he cited the $1.65 billion acquisition of YouTube and the development of Android, which is now the leading smartphone operating system in the world. The company reported that it continued to make progress with large advertisers in the first quarter, and said that CPC rates fell for a variety of reasons, but were well compensated by a 40% increase in the number of paid clicks. The company also revealed that it had reached 100 million users for its social networking site, compared with 845 million users for Facebook.
In looking at what the future holds for Google, try not to get distracted by all the media coverage of the supposed smartphone battle with Apple (AAPL). Revenues from search services accounted for something like 96% of the company's revenues in the first quarter. Logically, this should be the starting point of our examination. Google's share of online queries in the U.S. has fallen more than 3% to around 64%, while Bing, the search engine from Microsoft (MSFT), has gained a similar share to now stand at around 30%. Though revenues for the first quarter rose by 24%, a significant decline in market share could have a big negative impact.
Encouraged by its recent success, Microsoft is spending money on and paying attention to Bing in order to enhance the search experience. Google is protecting its crown jewels, and the most recent initiative is called Knowledge Graph, which uses word associations much like the human brain to deliver more relevant search results. Though it still has more than 80% of the search traffic in the world, it is coming under pressure from local competitors such as Baidu (BIDU) of China, which is flexing its muscles in its home market. You can understand the magnitude of the threat when you appreciate that the Chinese economy is expected to overtake the U.S. economy by 2016.
I do not think Android is critical to the future success of Google. It is principally regarded as a means of expanding the search market. Moreover, because Android is an open source platform, the revenue streams are limited to the applications that can be developed and sold. Google is also looking to expand the platform on which it delivers cloud computing services, and Google Drive is closely integrated with its popular Google Docs service. Here, the competition in the form of other giants such as Apple, Microsoft and Amazon is going to be fierce and cutthroat. However, cloud computing does provide a means of generating fee revenues that are much more stable than advertising revenues. One of the critical factors to be considered for the future is how Google handles Motorola. Unfortunately, Google's past success is no guarantee that the Motorola acquisition is going to work.
I have no doubt that Google is a well-managed and innovative company that will be able to cope with all of these challenges. However, I believe that it is fully valued at the current stock price, and I would not recommend buying unless there is clarity about the future. If you have an existing investment, I would recommend that you hold on to it and watch future developments closely.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.