Majestic Research

Business Week

Google Beats the Bears: Despite Analyst Nay-Saying and Fewer Paid Ad Clicks Leading up to its First-Quarter Earnings Announcement, the Search Giant Reports Solid Growth

By Robert Hof
Published: April 17, 2008

The Google bears are scurrying back into the woods. On Apr. 17, Google quelled concerns that the slowing economy would finally hurt its business. Thanks to strong international growth and better payoffs from its search ads, Google (GOOG) turned in higher profit and revenue than Wall Street had expected. The shares jumped more than 17%, or about $75 a share, in extended trading, after the results were released.

Google had been facing increasingly stiff headwinds during the quarter, from reports of a drop-off in ad clicks on its search results pages (BusinessWeek, 3/3/08) to increasing competition and the departures of some key executives.

But the company reported that earnings, excluding employee stock compensation, rose 30%, to $4.84 a share, higher than Wall Street estimates of $4.52 a share. Gross sales were up 42% from a year ago, to $5.19 billion, while net sales after payments to Web sites providing traffic to Google totaled $3.7 billion. Both beat analysts’ expectations. “This will mean a sigh of relief from investors,” says Rob Sanderson, an analyst at American Technology Research. “Google came through with a very solid quarter.”

Google’s Effect

Google’s results add to signs that the faltering U.S. economy is having a muted impact on tech companies with growing international businesses. First-quarter results from IBM (IBM) and eBay (EBAY) were stronger than analysts had forecast (BusinessWeek.com, 4/17/08). In Google’s case, overseas revenue accounts for more than half the total for the first time. Other Internet companies also rallied in the wake of Google’s repost: Chinese search engine Baidu (BIDU) gained 8%, and Amazon.com (AMZN) climbed 3%.

First-quarter figures from Google may also hold clues to how another closely watched Internet company, Yahoo! (YHOO), will fare in efforts to resist an unwelcome takeover bid from Microsoft (MSFT). Better-than-expected results would give credence to Yahoo’s assertion that it’s worth more than the $31 a share Microsoft has offered. Yahoo reports first-quarter results on Apr. 22.

Currently “Well-Positioned"

Google CEO Eric Schmidt made clear the company expects few economic obstacles. “We do not see an impact at this time,” he said in an analyst conference call. “We’re well-positioned for 2008 and beyond, regardless of the business environment.” Moreover, in the event “economics change,” Google’s targeted ads should prove even more appealing, Schmidt added, referring to the idea that companies would demand advertising with a measurable impact.

The company’s bottom line also benefited as Google kept costs under control. Although the purchase of ad-serving firm DoubleClick added 1,500 people to Google’s staff, for a total of 19,156, the company slowed the pace of hiring. Google hired about 850 people, much fewer than the 2,130 it brought in the peak third quarter. It also laid off 10% of DoubleClick’s U.S. staff and expects 15% more to leave as the companies meld.

Responsible for Ad-Click Decline

One of the biggest concerns Google faced in the runup to its results stemmed from reports of a precipitous decline in paid clicks. Figures from market researcher comScore (SCOR) suggested paid-click growth had screeched to a near-halt, rising just 1.8% in the first quarter from a year ago. Google measures paid clicks differently than comScore, which employs a panel of Internet users to gauge clicks. By Google’s count, paid clicks rose 20% from a year ago and 7% from the fourth quarter.

That’s still down from 30% year-over-year growth in last year’s fourth quarter and 45% growth in the third quarter. The slowing had put Google’s results under a microscope and contributed to the pessimism that prompted at least 16 analysts to reduce Google earnings estimates. Investors had hammered the stock, sending it down 34% so far this year, to 449.54 on Apr. 17 before the earnings report. In extended trading, Google stock rose to 525.96.

Google has attributed virtually all the decline in paid clicks to changes it purposely made. Late last year, it decreased the clickable area around ads to reduce accidental clicks. It also has been gradually reducing the number of search results that return paid ads by tweaking its search formulas to discourage ads that link to sites chiefly intended to capture clicks rather than sell products or provide useful content.

The result, Google and many analysts contended, should be an increase in what advertisers pay per click, since those clicks will be from more serious buyers. That appears to be just what happened. American Technology Research’s Sanderson says revenue per paid click rose 17.2% in the first quarter, up from a 14.7% gain in the fourth quarter and a 7.6% increase in the third quarter. Search marketing firms concur that clicks are getting more valuable. “Click prices continue to move up slowly and steadily,” says Kevin Lee, executive chairman of search marketing firm Didit.

Concerns for the Future

Even if Schmidt doesn’t see clouds on the horizon, other recent reports suggest the company faces challenges ahead. Search marketing firm SearchIgnite said Apr. 15 that Google’s share of search marketing spending fell to 70.4%, from 74.5% three months ago, largely at the expense of Yahoo, whose share rose from 19.6% to 24.2%. “We’re concerned about intra-quarter trends that showed declining growth,” says SearchIgnite CEO Roger Barnette.

And while Google’s numbers show ad-click growth isn’t slowing as much as comScore figures indicate, some analysts remain concerned about the decline nonetheless. Google still hasn’t proved the price-per-click increase is big enough to make up for the overall decline in clicks, says Clayton Moran, an analyst at Stanford Group. “It wasn’t as bad as the original fears…but the results don’t negate the trend,” Moran says. “It is clear that growth is decelerating rather rapidly.” Moran has a hold rating on Google, with a $500 price target.

Economic Impact

John Aiken, managing director of Majestic Research, believes that besides Google’s own changes, most of the decline in paid clicks is due to Google’s mainstay small and midsize business customers cutting back their search-ad spending as the economy sours. “If you’re less likely to search for a vacation to Bermuda, you’re going to be clicking less,” explains R. Michael Leo, CEO of ad technology and services firm Operative.

At the same time, however, Leo sees no slowdown in online advertising to date. And the impact of the slowing economy on online advertising could yet go in Google’s favor. Although few believe the industry is immune to a recession, a downturn could drive more ad money online because ads there are more accountable, noted Andrea Kerr Redniss, a senior vice-president at ad agency Optimedia, who spoke at an ad technology conference in San Francisco Apr. 15. If so, it appears Google is in a position to benefit as much as anyone.