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Summary:

Et tu, Google? Yahoo’s stock sank following its Tuesday earnings report, as did eBay Wednesday despite some signs that revenue and profit growth are looking up. But I can’t think of anyone who was expecting Google to disappoint Wall Street with its second-quarter numbers. And yet […]

Et tu, Google? Yahoo’s stock sank following its Tuesday earnings report, as did eBay Wednesday despite some signs that revenue and profit growth are looking up. But I can’t think of anyone who was expecting Google to disappoint Wall Street with its second-quarter numbers. And yet that is exactly what happened: The stock was down as much as 8% in after-hours trading, which this week has been a pretty good indication of what will happen once the official stock markets open tomorrow.

That’s all short-term stuff. To ask the big question facing Google, we must turn to Cole Porter: “Is it an earthquake, or simply a shock?”

I had been inclined to go with the shock theory but then I listened to the conference call. It was, in my experience, the most unsettling Google call in at least a couple of years – and I’ve been listening in ever since the company went public. I can’t quite put my finger on it, but the Googlers seemed very much off their game today.

But first – as they say on the radio – the numbers. Google posted a $3.56 a share profit if you don’t use GAAP accounting, or $2.93 a share if you do (it all depends on how much you care about stock-based compensation). Either way it was below what sell-side analysts were expecting: $3.01 on a GAAP basis, and $3.59 on a non-GAAP basis.

Neither of these numbers would be alarmng except that everyone is used to Google coming in and shooting out the lights – earning-ly speaking. They did merely pretty good, instead of f—–g great. But everyone has long since grown used to f—–g great. Hence the “shock.”

If this all sounds like Googledygook, I agree. But it’s hardly Google’s fault. Combating accounting fraud has forced the introduction of rules that actually make the average investor’s head spin. Normally – that is, when things are going well – Google takes pains to filter out the accounting complexities, and to make its own accomplishments clear.

This quarter, it didn’t, and that’s exactly what worries me. So here’s my best stab at explaining what went on at Google last quarter.

Yes, Google made more money than ever before – no surprise there. And, as you’d expect from an ever-larger company, it did so at a slower rate. But the revenue growth rate was disarmingly slow: 6% higher than its last quarter. That’s the lowest quarter-on-quarter revenue growth that Google has shown since it went public. Is that what you’d expect from the company that’s causing Yahoo so much pain? Hardly.

One key goal of a public company is to grow profits faster than revenue. When that happens profit margins grow, a good thing. But thanks to even greater spending on infrastructure and new hires at Google, that means those margins have fallen. Why? Simply put, Google hired more people than it meant to. (Hello, new hires: Watch out for those pink slips!)

Google’s position on this trend centers on two points. First, it always said that, as it grew, it would at times see its margins decline. Fair enough. And also, its lower margins this quarter were tied in part to the way it accrued financially the bonuses it has been paying to workers. Apparently, a change in the bonus calculations caused some bonuses made in the first quarter to be shoved over into the second quarter. Again, fair enough.

Now, using the knowledge that any Google investor knows, I want to try and show why those two explanations don’t quite hold up this quarter. First, let’s look at the margins Google disclosed: The amount Google spent to cull in that 6% blip in revenue was equal to 28.5% of revenue. But a mere 3 months ago – when investors were cheering Google – it was 33.3% of revenue.

So telling your investors that you’d expect margins to decline as you grow is one thing. But having them drop 5 percentage points in three months is quite another. So Google wants to attribute some of the higher employee costs to this shift in bonus accrual. But when several analysts asked how much of the bonus re-jiggering caused the lower operating margins – and they asked several times – Google played coy. Who knows?

And that brings us to my main question for Google: If the company is powerful to scare eBay and corner Yahoo, why can’t it answer the most humble questions? So you overhired this quarter – is that so bad? Why fudge it with this bonus-accrual smoke? To regress to high school lingo, it all feels a bit wussy.

Go back and listen to the earnings call. Schmidt dishes up the usual platitudes about growth (and they seem a little more disconnected from reality than usual), while Page seems muted and Brin coughs out the nervous tic “and whatnot” six times in about 20 minutes.

We expect a bit more from our overlords: Say Google rules all, and yet Google holds a conference call no one pays attention to – what does that mean for media? Sure, print and TV and even Google rivals are falling under the wheels of the Google mack truck, but once we stop caring about Google, where does that leave the rest of us? What if it were an earthquake?

  1. Ohh history will be your best guide here..if its not rounding the top of the mountain on way back down now will be soon! They are all over the map these days, more vulnerable than ever to smart niche competitors (Quigo, Fbook, Veoh/Brightcast), Youtube is a big mess and anchor, and Internationally their Adwords/Adsense machine wont find the same success as in US over long term.. And the faster the brains keep leaving, the steeper the fall will be…

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  2. stocks go up and down all the time right?
    anyway the bubble is really big right now heh, but if it really bursts then everyone will die together.

    http://m-hawk.blogspot.com

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  3. Google is human…

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  4. Google slowing down?

    GigaOm has a nice opinion piece on Google’s recent investor conference call.  It’s inevitable that Google’s rate of growth will slow down.  They are going to start to face the challenges of other businesses where they have to figure out…

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  5. OM

    When you look at all the leading edge / innovative companies (technology or otherwise) their average life span at the TOP of the Innovators Charts is 5 years.

    That’s an average! and Google has had a great run and I think will go the distance and then some.

    But in order to do that they will need to create new businesses that take them into areas outside their core ad business

    But I do think this is a sign that perhaps the core is beginning to age

    my 2 cents
    pd

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  6. Katie, I quit reading your posts due to your tasteless use of foul language.

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  7. [...] Kelleher writes: Yes, Google made more money than ever before – no surprise there. And, as you’d expect from an [...]

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  8. mikeelliott1 Friday, July 20, 2007

    One of the biggest problems with investing in this day and age is that anything less than meteoric from a company that has been meteoric is considered unacceptable. Kind of like how political pundits faced with reductions in the rate of growth in spending on their favored social programs call them “cuts”. This could be a blip on the radar or it could be the beginning of a downward trend. But no one will know for sure until after a few more quarters for comparison’s sake.

    http://mikeelliottsblog.wordpress.com

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  9. I wonder at all if this is impacted by all of the acquisitions that google has done this year? I read an article the other day that said google had more acquisitions in first quarter 2007 than in all of 2006. They are still performing, but maybe this is why that aren’t still knocking it way out of the park?

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  10. Great insight and analysis as usual, Kevin.

    Maybe Google is “human” afterall…certainly good news for their competitors…including those able to snag some of their top talent using options as compensation honey…

    ps Sorry to see you using the “f” word.

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