Google Checkout Launch A Positive for Both Google and eBay (GOOG, EBAY)

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Includes: EBAY, GOOG
by: Tim Boyd

Caris & Company analyst Tim Boyd addresses clients on Google's (NASDAQ:GOOG) recent launch of its much anticipated online payment solution yesterday, dubbed “Google Checkout.” Some highlights of the offering follow:

The initial rollout will include roughly 100 online merchants. Some examples are Buy.com, Starbucks (NASDAQ:SBUX), Zales (NYSE:ZLC), GNC, Tweeter and Ace Hardware.

For every $1 a merchant spends advertising with AdWords, Google will process $10 worth of payments for free. Assuming constant click-thru/conversion rates, this results in a lower overall cost of advertising (about 20%) on Google and therefore a higher ROI for merchants. It is unknown how long this promotion will last, but our sense is that it will remain in place until Google feels that Checkout has hit an inflection point in terms of consumer and merchant adoption.

Many service providers have already integrated Google Checkout with their e-commerce platforms. Some examples are GSI Commerce (NASDAQ:GSIC), MonsterCommerce, and ChannelAdvisor.

The service conceals the buyer credit card number and provides reimbursement for unauthorized purchases . These features should help allay (at least in part) consumers’ privacy and security concerns.

We view the launch as a potential long-term positive for Google for the following reasons:

Checkout has the potential to drive incremental AdWords revenue growth. Consumers who sign up to use Checkout will be more likely (at least in theory) to click on paid search ads that include the Google Checkout icon (indicating that the merchant accepts Checkout). This would drive higher click-thru and conversion rates for Checkout-enabled advertisers, thus increasing demand for AdWords and therefore revenue to Google.

Checkout is likely to be an important cog in Google’s CPA machine. One of Checkout’s most important benefits to Google could be in cost-per-action (NYSE:CPA) advertising. We know that Google is moving towards a CPA offering: a few weeks ago it sent an e-mail to its existing AdSense customers inviting them to test some new CPA functionality on their site. Given the frothy growth in both CPC keyword pricing and volume over the last several years, not to mention advertisers concerns about click fraud, the CPA model is likely to become an increasingly important aspect of online advertising. Checkout should help make CPA advertising more attractive for advertisers (i.e., it should make them more willing to pay the higher price for a CPA ad) and profitable for Google by enhancing the chances that a consumer will 1. click on a ad and 2. consummate the click-thru with a transaction. Recall that in a cost-per-action ad, Google doesn’t get paid unless both occur.

A potential source of incremental, high-margin revenue. We don’t expect Checkout to have a meaningful impact on Google’s P&L anytime soon, but if/when it does the impact on Google’s bottom line could be substantial due to the high-margin nature of the revenues (~30%). Note that this is lower than Google’s overall operating margin (59% in 1Q06), so strong long-term growth in Checkout could actually end up pressuring Google’s margins.

A very large and underpenetrated addressable market. Total U.S., non-eBay e-commerce sales were $143B in 2005, according to Forrester. Total non-U.S., non-eBay (NASDAQ:EBAY) e-commerce sales were $238B in 2005, according to IDC. That’s a $381B addressable market. In 2005, PayPal’s Total Payment Volume was $27.5MM, and the vast majority of that took place on eBay. So PayPal, which has been the online payment leader for several years, has penetrated a de minimus amount of noneBay e-commerce sales. This indicates that a lot of low-hanging fruit remains for both PayPal and, if it is adopted by enough merchants and consumers, Google Checkout. (Note that Checkout is currently available only in the U.S. but that Google is working to make it available internationally).

A potential source of valuable consumer behavioral data. One of ways in which Google lags some of its competitors (such as eBay, Microsoft (NASDAQ:MSFT) and Yahoo! (YHOO) is its relative lack of information about its users. Users don’t have to register in order to use Google search, and since search remains the run-away #1 reason why any user visits Google.com, Google doesn’t capture a whole lot of information about the visitors to its site. This puts it at a significant disadvantage vis-à-vis its ability to behaviorally target ads. Google’s superior search algorithms have enabled it to almost singlehandedly drive the tremendous growth in paid search advertising, but to maintain its dominant market share over the long haul it will likely have to offer advertisers the ability to target ads based on consumer habits and demographics. That’s where Google Checkout comes in: Google will know users’ names, addresses and telephone numbers and will have a record of what and where each user purchased online.

If any of these benefits are to be realized, Google Checkout will, of course, have to be adopted by both merchants and consumers on a widespread basis. Google is doing the smart thing by using processing subsidies to entice merchants to sign up for Checkout. After all, who among them wouldn’t want to either save 20% of their current keyword budget or get 20% more for the same amount of money? We believe, therefore, that merchants who advertise with AdWords will aggressively adopt Checkout. The key question, however, is whether or not consumers will aggressively adopt it. For this to happen, Google will have to overcome concerns about privacy and security. It is important to note that Checkout is not a natural extension of Google’s search functionality for most users. As we noted above, users don’t have to register to use Google.com for search. This presents a barrier to Google, because now it is asking searchers to surrender both their anonymity and financial data in return for a more convenient online shopping experience. Consider the following graphic from eBay’s recent Analyst Day presentation:

Goog checkout

Based on this survey, the majority of online shoppers worry about identity theft, stolen account information, spyware and fraudulent e-mails. And these are existing PayPal users, i.e. consumers who are obviously at least somewhat comfortable shopping online. Our guess is that the “worry rate” returned by a broader survey of online shoppers would be even higher. The key point is this: Google has no track record when it comes to combating buyer/seller fraud and protecting user privacy. PayPal, on the other hand, has been developing sophisticated security techniques for years. For Checkout to be successful, Google will have to convince consumers that it can be trusted, and only time will tell whether it is successful in this endeavor.

Finally, we view the launch of Google Checkout as a positive for EBAY shares. Why? Because the market will finally be able to see that Checkout poses only a very limited threat to PayPal, which should in turn improve the sentiment on the stock. Despite being portrayed by many in the media as a “PayPal Killer,” we think it highly unlikely that Checkout will crimp PayPal’s very strong off-eBay growth prospects in the foreseeable future. For reasons discussed earlier, the burden of proof is on Google to show that Checkout will be widely adopted by consumers. PayPal, which is by far the most successful of the few online payment companies that have even survived over the years, has already begun to harvest some of this low-hanging, off-eBay fruit. With an established base of more than 100MM users (and growing fast), we think it very likely that it will continue to do so.

GOOG-EBAY 1-yr comparison chart:

GOOG-EBAY 1-yr comparison chart

For related article on the recently launched Google Checkout, see:

- Is the Recently Launched Google Checkout a Loss Leader?
- Google Checkout Plus CPA Ads: Valueclick Killer Indeed
- Thoughts on Google’s New Checkout Payment Service
- Who Loses From Google Checkout? Not eBay, but Amazon

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