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Gaga for Google
No. 1 search engine's sales more than double, trouncing forecasts; stock rallies.
October 22, 2004: 11:30 AM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - Google, in the first earnings report since its initial public offering in August, posted strong gains in sales and earnings Thursday. But earnings, at first blush, missed estimates.

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Nonetheless, the stock moved higher after-hours and jumped nearly 12 percent in early trading Friday morning. Wall Street appeared to be excited about the solid sales growth as Google (Research) demonstrated gains that outpaced top rival Yahoo!

One Wall Street firm, Prudential, raised its 2004 and 2005 earnings estimates sharply Thursday evening and slapped a $200 price target on Google, up from its previous target of $130. That's nearly 34 percent above where Google's stock closed on Thursday.

Sales in the latest quarter more than doubled from a year ago to $805.9 million. Excluding the advertising revenue that Google shares with partners, or so-called traffic acquisition costs (TAC), sales came in at $503 million. Analysts were predicting $456 million.

Google reported net income of $52 million, or 19 cents a share, up from $20.4 million, or 9 cents, a year earlier. That was better than expected since Google had said it expected to report a net loss due to a charge for a legal settlement with Yahoo! Excluding that charge and a tax benefit related to stock options, Google reported net income of 45 cents a share.

The Wall Street consensus estimate was for 56 cents.

But during a conference call with analysts, Google executives said in response to an analyst's question that if you factor out a $68 million charge for stock-based compensation, earnings actually came in at a better-than-expected 70 cents.

Digging through the muck

Confused? Wall Street certainly was. The stock initially slipped as much as $4 in volatile trading after-hours, but shares then shot up more than 8 percent as Wall Street began to digest the somewhat perplexing report, which was released first on Google's Web site and then across the news wires, a move befitting Google's reputation as a quirky company.

During the conference call with analysts, Google Chief Executive Officer (CEO) Eric Schmidt joked that the company is unconventional. He reiterated that the company will not provide earnings guidance.

Google's first two months since the IPO have been grand...and the stock may head even higher following its first earnings report.  
Google's first two months since the IPO have been grand...and the stock may head even higher following its first earnings report.

Google has been criticized by some on Wall Street for taking this stance, and as a result, there is a wide disparity in earnings estimates for 2005. That isn't likely to change.

"Folks will still be all over the map, starting from revenues on down. Google did make some comments that were somewhat forward looking on the call, but they were more general than anything else," said Scott Kessler, an equity analyst with Standard & Poor's.

Still, investors appeared to brush off the bewilderment about the net-income number, focusing instead on adjusted earnings before interest, depreciation and amortization, or EBITDA, another measure of profitability often used to judge media companies.

Adjusted EBITDA, which also excluded the costs of the Yahoo! settlement and options expenses, came in at $321 million for the third quarter -- well ahead of the $282.6 million that analysts were expecting, according to Thomson/First Call -- and up 16 percent from the second quarter.

With this in mind, John Tinker, an analyst with ThinkEquity Partners, also raised his target to $200 a share, from $145, following the results. He said that despite the confusion about the earnings and lack of guidance, it's hard to ignore the company's stellar growth prospects.

"It's an incredibly frustrating company but the numbers were really terrific," Tinker said. "If you want growth, Google is the place you go. There are very few companies with these kind of growth numbers."

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And investors also appeared to be impressed by the extremely strong sales growth. Revenues increased 15 percent from the second quarter and excluding TAC, they were up nearly 19 percent sequentially. That level of growth was markedly higher than what Yahoo!'s marketing-services business reported in its third-quarter results last week.

"It was a very impressive quarter. I would expect fourth-quarter numbers to move higher," said Marianne Wolk, an analyst with Susquehanna Financial Group. Currently, analysts are forecasting pro forma earnings of 63 cents per share for the fourth quarter, on sales, excluding TAC, of $523 million.

During the conference call, Google Chief Financial Officer George Reyes said an expected seasonal slowdown in search-based advertising over the summer did not materialize for Google, thanks to strong traffic on the site. Reyes said, though, that flat revenue growth from the second to the third quarter will be the norm in the future.

One of Google's founders, Larry Page, added during the call that, although some investors are concerned about the company's dependence on online advertising for the majority of its sales, he thinks the search market is both large and in its infancy.

Page also stressed that the company will continue to launch innovative ways to grow its revenue base, such as the use of image-based ads.

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Some analysts have argued that Yahoo! deserves to trade at a premium to Google since Google has no other major revenue streams while Yahoo! generates more than 15 percent of its sales from fee-based businesses. But Tinker argues that if Google keeps posting quarterly results as strong as the third quarter, Google might soon find itself the more richly valued stock.

"Maybe Google will eventually deserve a premium because its growth is faster. But the discount to Yahoo! should begin to shrink," said Tinker.

To that end, shares of Google, based on Thursday's close, traded at about 53 times 2005 earnings estimates, compared to a P/E of 73 for Yahoo! But after factoring in Friday's surge, Google now trades at about 61 times 2005 earnings estimates while Yahoo! has a P/E of about 75.

Google has nearly doubled since going public in mid-August on optimism about the company's fundamentals. Kessler said that even though he's a bit wary of Google's stock, because it trades at a very high earnings multiple, he doubts this will slow the stock's momentum.

"This is one of those stocks where it appears pretty obvious that people will buy it based on the company's fundamentals and are not going to pay a heck of a lot of attention to valuation," said Kessler.

The excitement over Google's prospects filtered down to the rest of the search market as well. Yahoo! (Research) shot up nearly 3 percent Friday morning, as did smaller search companies Ask Jeeves (Research) and FindWhat.com (Research). And shares of another smaller search firm, LookSmart (Research), were up about 9 percent.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking ties with the companies.  Top of page




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