Analyzing Google (GOOG)

By Yaser Anwar, CSC of Equity Investment Ideas

• Google reported net revenue growth of 20% in the Q to $2.23B (EPS $3.29, excluding $133 million tax benefits EPS is $3.18), higher than Street estimates in spite of approximately 200 basis points increase in traffic acquisition costs as a percent of revenue.
• Google’s incremental cash flow margin in the quarter was 60.8%, down 100 basis points from Q3. Lower gross margin also impacted operating margin, which came in at 47.6% vs 49.9% reported in Q3. R&D expense was slightly higher than Street estimate and was offset by lower sales & marketing spend. On a pro-forma basis, operating margin was 53.6% in Q4 vs. 55.3% last Q.

• However, Investors should expect margins to continue trending down as Google invests aggressively in new growth opportunities (international, video, media partnerships and mobile etc).

• I heard on CNBC that Google grew 3x faster sequentially than YHOO Search did on a YoY basis. When I researched (hey! you shouldn’t just take ’em for their word innit? 😉 I came across Goldman’s analyst who said-

"GOOG’s 19%+ QoQ growth reflected a ~1700 bps spread over Yahoo!’s normalized 3% QoQ search growth rate compared to the average 1,400 bps spread historically seen in the 4Q as Google continues to drive superior monetization of its commanding search market share both domestically and internationally."

• Google-owned sites revenue was $1.98 billion, 80% YoY, representing 62% of gross revenues. Revenues from Google’s network of affiliate sites was $1.2 billion, 50% YoY representing 37% of gross revenues.
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• International revenue was $1.41 billion, +93% YoY growth, which represented 44% of total revenues. US sales were also strong coming in at $1.8 billion, growing at a clip of 51% YoY. Management pointed to contributions from Australia, Latin America, Ireland, and Brazil. Furthermore, management explicitly indicated several times on the call (you should hear them or read transcripts too! 😉 that growth in the US remains solid.
• I believe Google represents the best of breed category when it comes to profiting of Internet and ad revenue growth! While growth is slowing it is occurring at a much slower than anticipated rate while the much talked about decline in margins has been slow to happen. A year ago, consensus expectations for 07 revenues and EPS were $9.0B & $11.63. Since then they have risen to $10.8B & $13.92, while Google’s stock has risen only 15%.
• In my opinion, GOOG is undervalued. Why? With shares trading at 28x 08 EPS, and EPS growing over 35% in the next 3-5 years. Furthermore, Google shows no signs of slowing down its investments or partnership activity, and higher revenue sharing, Checkout subsidies etc are likely to help it accelerate, even though margin pressure will exist.

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