Google’s Earnings, All About Expenses (GOOG, YHOO, MSFT)

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Tonight’s headlines are going to be dominated by one event… Google’s (NASDAQ:GOOG) earnings.  First Call estimates on last look were $3.78 EPS and $2.94 Billion in revenues.  The revenue number is on an ex-Traffic Acquisition Cost basis.  We have recently seen many analysts up their targets on the stock, sothis ‘earnings estimate’ is now going to be a mere lower-end benchmarkwhere many are looking for a blowout number.

This stock has been on a rampage with shares up roughly 10% this month alone, and shares are up 20% since the end of August.  But the October 11 highs over $640.00 have been acting as resistance in the recent trading days. 

Options expire tomorrow, but it appears that as of mid-morning that options traders are braced for a move of up to about $20.00 in either direction.  The cost of an at the money $630.00 Straddle would run over $34.50 on last look.  At the end of September there were 6,626,105 shares listed in the short interest according to NASDAQ.  International revenues were 48% last quarter, up from 42% in the June 2006 quarter and up from 47% in the March 2007 quarter. 

As a reminder, last quarter the company had a slight miss on earnings and much of the blame was on the costs of adding personnel.  Its last headcount was 13,786 full-time employees (not counting contractors) at June 30.  The company has already tried to warn traders about expense growth exceeding revenue growth, so if any analysts come out with "we are disappointed with expenses growing fater than revenues" then they aren’t reading the filings and aren’t listening to what the company says.  Last quarter had a $62 million transferable stock option charge and Google has already disclosed that it sees an additional $160 million charge being spread out in the coming four years.  As per the last quarter filing: "As a result of all of the above, the growth rate of our costs and expenses may exceed the growth rate of our revenues in 2007…..  We expect our cost of revenues to continue to increase in dollars and may increase as a percentage of revenues in 2007 and in future periods, primarily as a result of forecasted increases in traffic acquisition costs, data center costs and credit card and other transaction fees, including transaction processing fees related to Google Checkout. In particular, traffic acquisition costs as a percentage of advertising revenues may increase in the future if we are unable to continue to improve the monetization of traffic on our web sites and our Google Network members’ web sites, particularly with those members to whom we have guaranteed minimum revenue share or other payments."

We are releasing the first part of our "Small Cap Internet Watch List" Friday for our subscribers of the "Special Situation Investing Newsletter" from 24/7 Wall St.  We do not believe these are all going to be active takeover candidates, but we feel under the right circumstances that these could be acquired By Google, Microsoft, Yahoo!, AOL, IAC/Interactive, or a dozen other US and international media players.  In this we’ll offer insight, related deals, potential parents, and even potential values down the road.  Companies that have been on this list (and as our BAIT SHOP candidates) that have been acquired are 24/7 Real Media, aQuantive, Web.com, and DoubleClick when they were all public.

As a reminder, Google does not offer guidance in its calls.

Jon C. Ogg
October 18, 2007