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Federico Flom
Federico Flom
Articles (110) 

Tepper and Loeb Bought Google - My View

May 16, 2012 | About:
Google Business Analysis — I break down Google (NASDAQ:GOOG) into the following five drivers:

1) Google Search – own the business that redefined the Internet

2) Google Display Networks – the emerging beast

3) Mobile Dominance – Android many moves ahead on the chess board

4 International Growth – under-appreciated gem

5) Social and Relevance of Google+ – other irons in the fire

As opposed to more formulaic Wall Street thesis, I’ll present the Google investment themes and keep things big picture. Towards the end of this piece I’ll highlight a number of business trends and financial estimates.

Google Search:

Search continues to generate the largest part of Google’s total revenues (almost half). Google search provides a distribution platform where consumers are directed to highly relevant content which is effectively monetized by advertisers. The size of the overall digital advertising market is still nascent and every major branded consumer company has plans to continue to shift advertising dollars from traditional media to digital media. Online advertising only comprises about 15% of total advertising spend in the U.S., and less than this in the rest of the world. Industry experts expect this to grow rapidly and I estimate that half of advertising spend will be Internet related in seven to eight years. Google dominates analysis of content, relevancy and ultimately search on the Internet (65% share). Google as a search engine is used more than Yahoo, Bing and AOL combined.

Google Display Networks:

GDN is comprised of YouTube (a stellar acquisition), Google Content Network (which are the display partners), DoubleClick’s advertising exchange, and AdMob (for mobile display). Google Display advertising has traditionally lagged behind Yahoo (but now has caught up) which has been historically able to leverage the Yahoo portal and email in order to drive display adds. The problem for Yahoo is that search market share has declined while user engagement with the portal and Yahoo affiliate websites has trended lower.

Google has developed AdSense in order to optimize the display advertising with Google partners relative to content. This has been a home run for Google which has been one of only two companies to gain share in display adverting (the other is Facebook). YouTube was acquired for a mere $1.6 billion and has led to dominance in total videos online (the closest competitor is Hulu, and Google sites have 7x the content).


The success of Android (Google’s open source mobile operating system) has been stunning. Android has achieved No. 1 market share and caught the attention of the rest of the industry as evidenced by a number of lawsuits (Apple against HTC and Oracle against Google). Google’s strategy has been to gain meaningful share of the mobile operating system for smartphones, which has seen explosive growth. Upon having high market share and an installed base, Android ensures that mobile search is done with Google’s search engine which fosters more advertising revenues.

That is what Android is all about, market share and facilitating Google search. Let’s consider Chrome at this point, another awesome product with open source code that Google doesn’t make any money on directly. While Chrome isn’t a direct revenue stream, search conducted on Chrome is on a Google engine at a much higher rate than search with another browser. Voila, Chrome drives search which drives advertising revenues.

Back to Android, Google has mentioned that over 550,000 Android devices are being activated per day. Google Offers and Google Wallet are also initiatives which Google has some inherent advantages in that they will help drive future mobile search. Thinking about the future value of Android and mobile search, it becomes clear why Google acquired Motorola. We believe they will let Motorola run as a stand-alone business unit, and simply hold on to the IP which can be used to counter-sue aggressive legal attacks down the road from Apple and Microsoft. Motorola was purchased with a year’s worth of free cash flow and will be accretive to earnings so this was a reasonable “defensive” acquisition. Motorola will not earn the same ROIC as core Google, but it will be accretive to cash flows and EPS.


International revenues were 54% of total company in the second quarter. There is tremendous opportunity for outsized growth in this area which is often overlooked. Google has a developed business in the UK which is a slow-growth economy. This has been the result of earlier investment years ago. At present, Google has large enough businesses in a number of emerging economies which are helping to move the needle overall. In the recent quarter, Brazil and Russia were highlighted as growth drivers.

Social and Google+:

I view the recent initiatives with social and Google+ as call options on a much higher stock multiple. Note that Facebook has over three times the valuation multiple in the private market that Google is being awarded in the public market despite having better liquidity, and a more established business model. If Google+ can achieve partial success the initiative will help improve search relevancy by incorporating more social features (likes) and solidify Google’s status for years to come. Google is in beta test with Google+ and has only launched the product by invitation. Expect a large splash and marketing campaign to nationally launch the product when Google feels ready. Success in this area will drive the stock multiple higher.

Growth Rate:

I model Google revenue with a sustainable 20% or higher top-line growth rate. Sales growth should be higher than this over the next two years and sette into a 20% growth rate in 2013 and beyond.

A short-sighted Wall Street community does not give credit to Google for two important areas where the company has been successful in the past: innovation and acquisitive growth. I believe that Wall Street has a bias to the conservative side because analysts get very uncomfortable with forecasts they can’t support with precision. Even Google doesn’t know the precise monetization path for Android (and other initiatives) but they are focused on achieving superior financial results in the long run. Google has an excellent track record with achieving growth from mid- to large-size acquisitions as evidenced from YouTube, Double Click and AdMob.

Again, the Motorola deal was defensive in order to entrench the position of Android which has become quite valuable to the company and has the potential to move the needle

What Warren thinks about Google

Billionaire Warren Buffett, who is well known for his “no tech” investment philosophy, says he has no interest in buying shares of Google (NASDAQ:GOOG) or Apple (NASDAQ:AAPL).

Responding to a question about tech giants at Berkshire’s annual shareholder meeting in Omaha, Neb., Buffett said:

“I would not be at all surprised to see them [Goggle, Apple] be worth a lot more money 10 years from now… but I would not buy either one of them. I sure as hell wouldn’t short them either.”

Buffett says he considers both companies to be “too risky.” That risk assessment, however, is not, according to him, based on the company’s fundamentals, but on the fact that it’s too hard to estimate what they might be worth. Buffett says it’s difficult to determine their value and how they will fare in the future.

IBM (IBM) — in which Buffett has accumulated a 5.5% stake, or 57 million shares, making him one of the largest investors in the tech giant — by comparison, is easier to figure out, and Buffett said he’d be more comfortable investing in the Armonk, New York-based company.

“The chance of being way wrong about IBM are probably less, at least for us, than being way wrong in Apple or Google,” hesaid. “I just don’t know how to value them.”

Buffett told CNBC on Friday that he wouldn’t buy shares in Facebook’s upcoming IPO: “I’m an agnostic on a company like Facebook. Anytime you get a truly extraordinary business — and it’s obvious it’s an extraordinary business — they’re the hardest ones to value,” Buffett said.

Deutsche Bank recommends to buy the stock

Deutsche Bank analyst Lloyd Walmsley increased its price target on shares of Google Inc. to $675 from $649 while maintaining a "Buy" rating, after the company reported solid first-quarter revenues and operating profit, showing welcome operating expense discipline.

While Walmsley believes the shares may be range bound ahead of a difficult FX comp in the second and third quarters and Motorola Mobility Holdings Inc. integration, he sees meaningful upside potential in the fourth quarter driven by improving mobile CPCs in the holiday shopping season as well as ongoing market share gains in mobile and display. He views the stock as attractively priced relative to its growth.

Google reported $8.135 billion in net revenues, slightly ahead of the analyst's $8.075 billion and consensus of $8.094 billion (up 0.0% sequential net revenue growth versus his estimate of down 0.7%). Operating expenses was lower versus estimates on slower headcount growth (up 1.9% year-over-year versus his estimate of 3.9%).

As such, operating profits and EPS outpaced Walmsley's estimates, although lower taxes added $0.37 to PF EPS of $10.08 (versus his $9.40 estimate). Paid clicks accelerated again to 39% year over year, though CPCs declined 12% largely on a mix shift.

The brokerage is increasing its second-quarter and 2012 revenue and EPS estimates, largely on lower tax rate assumptions. The firm estimates 1.6% sequential net revenue growth in the second quarter (and EPS of $9.79), and 21% year-over-year net revenue growth in 2012 (versus 19% previously).

The analyst's 2012 EPS estimate now stands at $42.20, up from $40.55, of which about $0.80 is attributable to a lower tax rate assumption. For 2013, he estimates $47.82 in EPS, up from $46.42 previously, on 17% net revenue growth.

The next catalyst for Google shares is likely the close of MMI, which is expected soon. Walmsley believes any color around cost controls or the spin-off of parts or all of MMI would be received positively by investors, and any talk of investment in MMI would likely be received as a short-term negative.

The analyst raised the price target to $675, which is based on 16 times 2012 EPS. He thinks this premium to the market (S&P500 multiple of 13.2 times) is justified given the secular growth of Internet ads and better-than-expected growth at Google versus market growth.

Dan Loeb and Simons also like the stock

Dan Loeb's Third Point recently filed a 13-F with the SEC.

The 13-F reveals common equity and convertible equity holdings, but lots of information is missing. Since we have access to Loeb’s letters and stat sheets, we were curious about his portfolio changes. Additionally, Loeb bought more Apple Inc. (NASDAQ:AAPL), which he detailed the bullish case for in his latest letter.

Loeb’s stake in Apple Inc. has been confirmed at 362,000 shares, and Google Inc. (NASDAQ:GOOG) 280,000 shares.

Loeb has not detailed why he likes the search engine Google, but it is second favorite holding of hedge funds. Charlie Munger has stated that Google has the strongest moat he has ever seen.

Jim Simons, the math whiz and founder of hedge fund Renaissance Technologies, added positions in hundreds of stocks in the first quarter, according to a filing released today. According to his filing, he has 2,805 holdings.

Simons stake in Google rose to 456,948 shares by March 31 from 84,000 on Dec. 31, 2011. His stake is worth about $300 million.

Personal view on the stock

Google’s usage is still growing rapidly. Its advertising revenues are growing. Even that all-important number on how many people actually click on the ads displayed on its search pages is growing.

But the return Google is getting for each of those clicks — in effect, the ad rate — is declining.

Two major factors are blamed. First is the shift to mobile computing, where advertising rates are lower, presumably because advertisers aren’t yet convinced that it’s an effective medium for them. The second factor is more global, literally. All the growth for Google is in emerging markets, and rates there are lower, too.

Google brushes off both of the above as an over-simplification. The company line at its conference call was, essentially: This cost-per-click thing is way more involved than that, but we’re not going to try to explain it to you, because it’s complicated.

Fine. But Google investors can see which way that number is going, and it’s not pretty: The price-per-click declined 12% year over year, even while the number of users clicking rose 39%. And that follows a 6% decline in price per clicks a quarter earlier.

A few interesting angles on the story:

  • ThinkEquity analyst Ronald Josey, quoted by MarketWatch, maintains his buy rating on Google but predicts that the cost-per-click factor will continue to decline through 2012.

  • If this is Google’s problem, it ought to be Facebook’s problem, as the other Internet behemoth that has nowhere to grow but on mobile devices sold in emerging nations. But not yet. A new analysis shows that Facebook’s advertising prices, and the number of ads it displays on the site, both grew substantially in the past year, even though click-throughs—that is, the actual numbers of people responding to the ads—declined.

  • Finally, there’s the nightmare scenario. Eric Jackson, in Forbes, explains the seven ways that Google today closely resembles Microsoft in 1999.

About the author:

Federico Flom
Equity Research Analyst

Rating: 1.9/5 (9 votes)


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