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All signals go for Google
Online search leader reports spectacular 3Q numbers; stock surges
October 21, 2005: 8:47 AM EDT
By Paul R. La Monica, CNN/Money senior writer
Up, up and away. Google's stock looks set to hit a new all-time high following its strong 3Q report.
Up, up and away. Google's stock looks set to hit a new all-time high following its strong 3Q report.
Ga-ga for Google: Shares of Google have more than tripled since last year's IPO. Is $400 the next stop?
Ga-ga for Google: Shares of Google have more than tripled since last year's IPO. Is $400 the next stop?
Google CEO Eric Schmidt said that more ads from Fortune 500 companies helped to boost Google's revenue.
Google CEO Eric Schmidt said that more ads from Fortune 500 companies helped to boost Google's revenue.
INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER upgrades & downgrades earnings & warnings public offerings INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER

NEW YORK (CNN/Money) - It looks like Google lived up to the lofty expectations that analysts and investors had for the online search leader.

Google, thanks to extremely ebullient demand for keyword search advertising, reported that third-quarter sales nearly doubled from a year ago to $1.58 billion. And revenues, excluding sales that Google shares with partners -- known as traffic acquisition costs or TAC -- came in at $1.05 billion, well ahead of consensus estimates of $943 million.

The company reported a more than seven-fold increase in net income from a year ago, to $381 million, or $1.32 a share. And earnings per share, excluding charges such as stock compensation costs, were $1.51 a share, up from 70 cents a share a year ago and surpassing analysts' forecasts of $1.36 a share.

Google reported the so-called "pro-forma" number, which backs out certain costs and one-time gains, in addition to its net income on a generally accepted accounting principles (GAAP) basis this quarter in order to avoid some of the confusion that had taken place following prior Google earnings releases.

Often it was not clear until the company's conference call if Google had beat, met or missed earnings estimates since analysts were using pro-forma numbers in their estimates.

There was no such confusion this time around. Investors clearly loved the numbers.

Shares of Google (Research) surged more than 15 percent in pre-market trading Friday after falling nearly 2 percent in regular trading on the Nasdaq. Based on a pre-market price of about $350, Google appears set to open at an all-time high. And several analysts raised the price targets on Google to above $400 a share thanks to the strong report.

"People continue to find more and more to like about Google," said David Garrity, director of research with Investec U.S. "In a word: Wow."

Defying a seasonal slowdown

Google's shares have surged more than 250 percent since the company went public in August 2004. So it goes without saying that there has been considerable pressure on the company to not just meet earnings estimates but beat them by a convincing margin.

"Nobody really believes that the consensus is what the company is being measured by at this point. It's some other number," said Scott Kessler, an equity analyst with Standard & Poor's, before Google's results were released on Thursday.

It appears that Google delivered. The results were also a pleasant surprise since Google told Wall Street when it reported its second quarter results in July that investors should expect the company to be subject to the typical slowdown in Internet usage and online advertising during the sleepy summer months of the third quarter. Google obviously overcame this, however.

"Although this is typically a slower season for Internet properties, we had another exceptional quarter," said Eric Schmidt, Google chief executive officer in a written statement.

Some analysts also had expressed concerns about how robust earnings growth could be for Google since it has increased its spending lately as it launches new products. The company is currently testing a Google instant messaging service called Google Talk as well as a video search offering. To that end, the company reported a 165 percent increase in research and development expenses from a year ago.

Google also reported a 127 percent increase in general and administrative costs, due largely to an increase in hiring. The company said it had nearly 5000 employees at the end of September, up from about 4200 at the end of June.

In addition, Google explicitly said in a filing for its recent secondary offering that it expected its sales growth rate to decline over time and that its operating margins would come under pressure as well.

But during a conference call with analysts, Schmidt said that strong gains in online advertising, which accounts for nearly all of the company's revenues, offset the increased expenses and seasonal slowdown in Web traffic, adding that Google saw a pickup in adverting from larger Fortune 500 companies as well as smaller businesses.

Google's results come on the heels of a similarly strong third-quarter report from its top rival Yahoo! on Tuesday. Yahoo! reported better than expected third quarter sales and earnings and lifted its sales guidance for the fourth quarter. Shares of Yahoo! (Research) were up about 1.5 percent in after-hours trading Thursday.

Google, as it has done since going public, declined to give guidance. It seems safe to say though that analysts will likely raise their fourth-quarter targets due to the better than expected third quarter results. Currently, analysts are predicting that Google will report sales, excluding TAC, of $1.11 billion and pro-forma earnings per share of $1.60.

Investec's Garrity said that earnings estimates for 2006 are likely to increase as well. He said he would not be surprised to see 2006 estimates, currently at $7.34 a share, to move up to between $7.50 and $7.75 a share following the strong third-quarter results. With that in mind, he said the stock, currently trading at about 41 times 2006 estimates, is not unreasonably priced considering that earnings could easily increase by about 40 percent next year.

One fund manager that owns Google agreed that investors have no reason to worry about the price just yet either since its performance justifies the premium valuation.

"In our tech funds, where we want to own the best growth companies, we are going to continue to own Google until it is dramatically overvalued or momentum slows," said Allison Thacker, co-manager of the RS Internet Age and RS Information Age funds, which both own Google.

Prepping for battle?

During the call, analysts asked Google about plans for the future. Although the company is wildly successful in its core business of search -- according to data from Nielsen//NetRatings, more than 45 percent of all Web searches were done on Google, compared to just 23 percent on Yahoo! and 12 percent on Microsoft's MSN -- some analysts have expressed concerns about Google's dependence on search-based advertising and the fact that competition is likely to increase from Yahoo! and MSN.

"Every quarter you think maybe Google's performance is peaking," said Thacker. "But it is clear that they are still gaining market share. It is pretty amazing."

But Google has quickly built up a massive war chest to fend off its rivals. The company raised more than $4 billion in its secondary stock offering last month and now has about $7.6 billion in cash on its balance sheet. And that's led to speculation about what Google will spend this money on. Google has put in a bid with the city of San Francisco to build a wireless network that would offer free Internet access to all in that city.

Larry Page, one of Google's co-founders, hinted that the company may be interested in building out more wireless networks as well, which could be a threat to phone companies, cable companies and others that provide Internet access.

"We are excited about Internet access in general. With better access to the Internet, people do more searches," Page said. "San Francisco is an experiment." But he added though that the company does not have any current plans to bid on other wireless networking projects.

Google also recently announced an alliance with Sun Microsystems to offer some of Sun's open source software through Google's toolbar application. That move was viewed by some as a way for Google to potentially challenge Microsoft (Research) in the operating system and productivity software markets that it currently dominates.

And last week, a source told CNN/Money that Google is thinking of partnering with cable company Comcast (Research) to purchase a minority stake in America Online, the online content and Internet access business owned by Time Warner (Research), the parent of CNN/Money. Schmidt would not comment about the AOL talks but did say that AOL, Google's largest customer, is a "very valued partner."

Microsoft and Yahoo! are also said to be interested in either a partnership or acquisition of a small stake in AOL in order to capitalize on the company's large base of viewers at its AOL.com site.

For a look at more earnings coverage, click here.

For a look at Google and other Internet stocks, click here.

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

The reporter of this story owns shares of Time Warner through his company's 401(k) plan.  Top of page

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