Behind Google's Smoke Screen

| About: Alphabet Inc. (GOOG)
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Behind Google's (NASDAQ:GOOG) lackluster numbers for the last two quarter lies several larger problems.

Mobile clicks ramp up equate to lackluster revenue growth.

Google reported aggregate paid clicks were up 39 percent, but the average cost-per-click (this is actually the revenue per click for Google) was down 12 percent. While Google attributed it to "various factors" that can make its click prices fluctuate, the fact remains that ads generated from mobile devices are charged a much lower rate than the ones from PCs. As more and more clicks go mobile, we would see a trend of clicks increasing at a much faster rate than the revenue.

There is a point where a softer growth in the clicks would lead to a revenue drop, and Google has been very reticent providing information about where the trends are headed. Competition from Facebook is also a reason for softer revenue per click numbers, and there is a big uncertainty around the rate at which the cash cow that funds everything else at Google can grow.

Several assets have not monetized.

Google has had several initiatives in the past which have been phenomenally successful, but have not had any meaningful addition to the company's bottom line. The company does not report bottom lines from YouTube, Picasa, Gmail, Google Docs, Google Groups, Google Scholar, Google Finance, Google+ and Google Maps, as they are not very significant and pose uneasy questions for the management from analysts and shareholders. Google is not Apple (NASDAQ:AAPL) when it comes to monetizing their assets. Apple like Google develops their products with a deep sense of passion and commitment, while Google does this for charity and thrills, Apple manages to monetize the last ounce of blood out of its products.


Google always runs in to trouble when it comes to issues with privacy and patents. The company has been involved in many lawsuits with Apple, Oracle (NYSE:ORCL), book publishers and customers. The Internet company is being charged in a lawsuit for violation of the Federal Wiretap Act, for willful interception of communications and aggregation of personal information of its consumers for financial benefit, and the Stored Electronic Communications Act for exceeding its authorized access to consumer communications stored on its systems. The company was also found guilty of patent infringements in the Oracle trial and several class action lawsuits for invading privacy. The company recently acquired a treasure trove of patents by acquiring Motorola Mobility (NYSE:MMI), and the main intention seems to be to wage a mafia war on patents, rather than settling with competitors and saving precious dollar from frivolous lawsuits.

Lack of an adult in the room.

The company needs an adult in the room when it comes to handling Wall Street and meeting Street expectations. After reporting a horrendously bad Q4, 2011 numbers on January 19, 2012, an analyst was asking if the CEO was happy with the numbers reported (the stock was down about 10% in the after-hours by then) and the CEO's answer was a resounding "Yes." The company spends way too much on non-monetizing assets and patents, and comes up short with respect to bottom line-numbers. This is the reason why the company stock price has not moved in the last 5 years.

As much as we would like to think Google has rewarded its shareholders very well since its debut at $85 in 2004, we forget that the stock was trading at $600 in October of 2007 and has not done anything meaningfully in the last 5 years. Most of its gains came in the first 3 years from the time they went public. The company expanded its payrolls rapidly thereafter, along with moving into other non-monetizing products, which has had a telling impact on the stock price. The company needs a seasoned veteran within the senior management who can rally for shareholders internally to push Google to the next level, and I don't see this happening any time soon.

Diversions to several non-monetizing initiatives.

Google acts like they are the next NASA of the world. Google lives beyond its core strengths and assumes they should solve all the human needs and problems. The company has meandered without focus and invested billions of dollars on unmanned cars, genetic mappings, alternate energy and other discontinued products.

Motorola Mobility overhang.

On August 15, 2011, Google announced that it would acquire Motorola Mobility for $12.5 billion subject to approval from regulators in the United States and Europe. In a post on Google's blog, Google Chief Executive Officer and co-founder Larry Page revealed that Google's acquisition of Motorola Mobility is a strategic move to strengthen Google's patent portfolio. The move would put serious margin pressures on Google as Motorola Mobility is a loss-making entity.

The addition of 20,000 hires from Motorola Mobility with no cultural fit with Google is another serious problem arising out of the merger. In my view, the lower margins that Motorola Mobility will bring in to the combined entity have by no means been baked in to the price of the stock. Other handset providers running Android have already raised their concerns regarding the merger, and any attempt by Google to provide stepmotherly treatment to other handset providers running Android and favoring Motorola Mobility could lead to additional lawsuits.

Android margins.

Android, the operating system for mobile phones and mobile devices, has been phenomenally successful. The company has built a successful app store with 11 billion downloads thus far, and it is estimated that about 300 million devices currently run Android operating system, against estimates of about 400 million devices running Apples iOS operating system. Though the company has been very open about the number of downloads and devices sold, they have been very quiet when it comes to margins each device running Android brings to Google. I tried reading several conference calls and I could not find any good information on this front. This leads me to believe that there are no margins with Android and any attempt to increase prices will push device makers to operating systems that run on Windows 8.

We have already seen the trend where device makers do not want to be unduly dependent on Google for their operating system and hence have devices running non android operating systems. Google phone still looks like a pipe dream, and my confidence is low that they can execute well on hardware, given their poor show with Google TV in the past.

Corporate governance issues.

Google's initial public offering took place on August 25, 2004. A total of 19,605,052 shares were offered at a price of $85 per shares. Of that, 14,142,135 were floated by Google and 5,462,917 by selling to stockholders. The company when they went public created dual class of shares where the Class B shares (primarily held by Larry page, Sergey Brin and Eric Schmidt) would have 10 times the voting powers of class B shares held by the public.

On April 13, 2012, Google's co-founders, Sergey Brin and Larry Page, announced that the Internet giant would be revamping its corporate structure. The company is creating a class of nonvoting shares that will be issued for employee stock incentive plans, acquisitions and other stock sales. The move will allow Mr. Brin and Mr. Page to keep a tight grip on the company.

Google is proposing to have three classes of stock. Mr. Brin and Mr. Page will control the super-voting Class B stock, which have 10 votes per share and provide the two co-founders with voting control over Google. The Class B shares are convertible into the current publicly traded Class A shares, which have one vote per share and trade under the symbol GOOG.

Google is planning to add a separate nonvoting stock called Class C shares, which will trade publicly under a separate ticker. According to Google, Class C will have all the same rights as Class A shares including the rights to dividends, if and when Google ever pays them. Google is doing this so that the founders and Erich Schmidt can have greater than 50% interest in voting shares of the company.

The company also decided to issue a stock dividend that will have the basic effect of a two-for-one stock split. Each holder of a share of Class A or Class B common stock will receive one share of the new non-voting Class C capital stock. So after the dividend, a stockholder who currently owns one Class A share with a single vote will continue to own that share plus one Class C share without a vote.

While one can make the argument that those owning class A Google shares knew what they were getting in to during the IPO, no one can deny that they did not have a say in the introduction or prior knowledge of a class C shares, which further reduces the combined clout of all Google shareholders against three individuals. When things are going relatively well, the issue of voting rights is not a big deal but if the founders decide tomorrow to go crazy and take strategic decisions not in the best interest of majority shareholders, nothing can be done because of the existing corporate structure.

Pulling out of China was a mistake

In Jan 2010, Google announced that in response to a Chinese-originated hacking attack on them and other US tech companies, they were no longer willing to censor searches in China and would pull out of the country completely if necessary. On March 23, 2010, Google started to redirect all search queries from to (Google Hong Kong), thereby bypassing Chinese regulators and allowing uncensored search. David Drummond, senior vice president of Google, stated in the official Google blog that the current circumstances surrounding censorship of the Internet in Mainland China led Google to make such a decision.

This decision to pull out of China was made in haste, and has caused irreparable damage to Google where it has ceded the clear lead it had to Baidu. Microsoft was strategic to grab the opportunity and offered Bing to power Baidu's results in English. It would be a mammoth task to get back to the top of search in what is already the nation with the most internet users.


Google seems to be a company that has lost its focus right now. The company has to focus on core strengths and profits rather than doing things that interest the management. The company has to change the way they push ideas top-down and listen to the market more so than they do now.

Disclosure: I am long AAPL.