To Blodget on Google: Revenue Trumps Margins

Henry Blodget is out with another post claiming that industry insiders are telling him that Google (GOOG) is extremely vulnerable to an economic slowdown. The main thesis of the article is summarized below:

A consumer who had $100 to spend before the recession and now has $50 to spend will either:

1. Click on fewer links (resulting in less Google revenue) OR

2. Click on the same number of links but spend less (resulting in a lower advertiser ROI).

There is no doubt that slower consumer spending will lower the amount of money spent. This may translate to lower ROI per click. However, just because there is a lower ROI per click during a slowdown, does not mean that the return is no longer attractive to the advertiser. What the advertiser is looking for is relative effectiveness of different media. During a slowdown, internet advertising will outshine traditional media and emerge even stronger.

Immediate Gratification: Generate Revenue Quickly

If a business is struggling for revenues, its focus will be to cut spending on items which do not generate immediate revenue. Businesses will have to compete for a greater share of a stagnant pie and will adjust their plans accordingly. Strategic projects which will not return an immediate benefit will suffer.

When it comes to advertisement, the focus will be to generate the greatest immediate bang for the buck. This is very internet advertising outshines other media. A consumer searching for a particular item on the internet is much more likely to buy soon. So even if the ROI per click may go down, the need for that return (even if it is smaller) will be a lot more. Businesses will sacrifice margins to generate revenue; without revenue there is no business.

The cut-backs in advertising will be on strategic and brand-building campaigns which are oriented towards traditional media.

Consumer Behavior: Where is the Best Deal?

Another aspect to keep in mind is consumer behavior. When times are tough, people are more likely to shop for deals. And the internet beats traditional shopping and media hands-down when it comes to shopping for deals. I expect the market-share of internet retailers to increase during a recession, since consumers will be price-conscious and will be looking for the best bang for the buck.

Both these trends bode well for internet advertising. It is clear that on a relative basis, online advertising will emerge the clear winner during a slow-down. Further advertisers are much more likely to sacrifice margins rather than lose sales to a competitor.

Of course, if the slow-down is deep and extends for a long time, the entire consumer economy will be in trouble. However, Google is likely to emerge in a much better shape than others.

Trading Analysis

Google’s stock has been trading in the range I specified in my previous article. The support around $500 has held and the resistance around $514 is yet to be broken. Using out of the money calls to trade these moves is turning out to be a very profitable strategy.

Comments

[bill west]

People will still shop during a slowdown. However they will look to lower pricing, better value, and doing their purchases without having to drive on $3 per gallon gas. Now comes the internet- many sales tax exempt, shipping at reduced costs or free, and home or business delivery. Google provides the ability to see, shop, and compare products from the convience of your computer. The new internet advertising media is still in its infancy but businesses like the ability to analyze instantly there ad dollar effectiveness. Billboards, newspaper, and tv ads cant provide this information.

Lean and mean the internet will rule the day.
Disclosures- long Google