Google's (GOOG) recent earnings release shocked market participants and sent both institutional and retail investors into overdrive seeking answers to the question: Is Google's golden age of growth slowing down? A few short days before the disastrous news Google had leaped over rival Microsoft (MSFT) to grab the number 3 spot of the world's leading corporations by market capitalization, trailing only Apple (AAPL) and Exxon Mobil (XOM).
Companies that introduce game changing technology that leads to market domination have historically had to deal with the "What have you done lately?" question. Google transformed Internet search and the subsequent advertising revenue has been propelling the stock price ever upward. But the game is changing as mobile devices are supplanting desktops/notebooks as the point of origin for searching, and fellow tech giants Microsoft and Amazon are falling all over themselves to mimic the current champion of tech, Apple.
In this article, we look at the probability of Google maintaining its golden edge from two perspectives - its core advertising business and its foray into growth opportunities.
Facts and figures are not needed to reach a common sense truth - smaller screens mean less space for ads and therefore decreasing revenue. Google has always been a bit of an anomaly. Despite its impressive list of technological innovations, GOOG is essentially an advertising company. Again, you don't need to be a Certified Financial Analyst to realize Internet access is going mobile at a dizzying pace.
Put the two together and how much trouble does that spell for Google going forward? For Fiscal Year 2011, Google derived 51.5% of its revenue from PC Search Ads and only 6.19% from Mobile Search Ads. By 2019, Mobile Search Ads will grow to 37.1% of total revenue while PC Search Ads will decline to 23.2%.
However, Google is still expected to dominate the expanding mobile search category, according to eMarketer, a digital media statistical analysis firm. Here is what they see for mobile ad revenue growth through 2014:
The potential problem for Google is not total revenue but the price per click that GOOG can charge in its heretofore insanely lucrative business model. In short, Google's total volume may be increasing, but its cumulative paid clicks are heading the other direction, as you can see from the following chart from Business Insider:
Google's net advertising volumes will compensate for declining revenue per ad, but it is doubtful the numbers will be sufficiently high for Google to continue to "lay golden eggs." As the eMarketer chart above indicates, there is growing competition in that space and in a world where tech breakthroughs can surprise, who knows what the future will bring. To avoid the fate of many dominant companies who slip into somnolence, Google needs new growth opportunities.
Google recognized the growth potential of mobile devices when it introduced the Android operating system for smartphones and later extended its use to the exploding tablet market. Android mobile devices have garnered impressive market share. For further growth, both Google and Microsoft are going after Apple by creating their own computing and entertainment ecosystems.
The genius of the Apple ecosystem is the bringing together of hardware, software, and content in a synchronized environment where services and apps remain in the "cloud," enabling the creation of faster and lighter devices. Apple has amassed its stunning record of success because their products both hard and soft are easy to use and reliable, largely because they own and operate every piece of the ecosystem.
Google is rushing into the fray with its own attempts at a true ecosystem, and they have the cash on hand to withstand repeated attempts at cracking Apple's dominance if need be. As of the most recent quarter, Google has $45.7 billion cash compared with $27.6 billion at Apple.
Google has the software and services pieces in place, but haa largely left the hardware to network partners like Samsung. Android phones now surpass iPhones in market share spread across several manufacturers and Android tablets are gaining. In stark contrast to Apple's closed system or "walled garden," Google's Android is open source, and Google generates no direct revenues from Android sales. The company benefits from mobile advertising.
Developers love the freedom of open source projects, but the end result is often products that are less reliable than counterparts totally controlled by Apple. In the summer of 2012 Google introduced its revamped Android Market store with the new and improved Google Play moniker. Google Play has over 600,000 apps along with movies, TV shows, and books to compete with Apple iTunes.
Google also introduced its latest Android Operating System - Jelly Bean - which has a faster interface, offline voice activated typing, and voice search. Other new entrants in Google's ecosystem include the Nexus Q and Google Glass.
The final two could lead to a pathway for Google to return to glory. Google Glass is a head-mounted display with the capability of a Smartphone. It is still under development with a possible release to the consumer market in 2014. The Nexus Q is a media player that will allow users to stream media from Google Play directly on their televisions. For investors, what is significant about the Nexus Q is not what it can do as much as who will make it. According to the Washington Post, the device is to be manufactured here in the U.S. by Google itself, although cloaked in a veil of secrecy, with the product release date delayed.
The Nexus Q represents Google's first attempt at building its own hardware. Google has a well-deserved reputation for excellence in innovation, and the game-changing potential of hands-free operation of a head mounted frame that acts like a smartphone is the latest evidence. For Google to compete with Apple on a grand scale, the company needs to follow Microsoft's lead and move into the hardware device space.
Microsoft is about to release its Surface tablet computer, which has features like a flip stand and a keyboard built-in, unlike the iPad, where these are only available as accessories. The Microsoft Xbox/Kinect is another hardware device owned and operated by Microsoft.
Google needs to follow suit and the company has the means to do it through Motorola Mobility. Google has as yet to do much with this expensive acquisition but the potential is there to expand the manufacture of Smartphones and tablets and move the production of the Chromebook to Motorola. This could give Google the reliability advantage that comes from control of both hardware and software while maintaining the consumer choice advantage through network partners like Samsung, HTC, LG and others.
Google has a major press event coming up on October 29, 2012. While the announcements are expected to center around Android phones and tablet updates and a possible larger Android tablet, watch for any hints of the company's plans for Motorola Mobility.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.