The Bear Take on Google

Google (NASDAQ: GOOGL  ) shareholders have a lot to be bullish about in 2013, but too much enthusiasm can lead to poor investment decisions. The human psyche loves tricking us into "knowing" that we own the greatest companies to have ever roamed the earth! This is especially true if we fail to balance our expectations by not taking into account what can go wrong within our investment thesis. In other words, if we're super-duper bullish about Google's future, it's a good idea to challenge our own convictions. It's time to bust out that bear suit.

CPC woes
The "smart"-device revolution the world is currently experiencing is both a blessing and a curse for Google. On one end, it's been the driver for the next billion Internet users, and on the other, it's caused Google to struggle with monetization on a cost-per-click basis. Smart devices typically don't have as much screen real estate to serve ads as PCs do, giving Google less opportunities to make money. As a whole, CPC is sensitive to a host of other factors including currency fluctuations, emerging markets, the macro environment, google.com versus its ad network, and the overall quality of the ads. Together, these factors have sent CPC into freefall over the last four quarters, with the most recent reported decline of 15% on a year-over-year basis. The moral of the story here is that even if Google nailed mobile advertising perfectly, it still may not be enough to reverse the underlying CPC trend.

TAC trouble
Traffic acquisition costs, the portion of Google's revenue that's shared with its partners, has been steadily on the rise over the last 12 quarters. This shouldn't pose a problem for Google as long as it doesn't have to continuously dole out a larger percentage of its revenue. However, as of the fourth quarter of 2011, TAC as a percentage of overall revenue has been on the rise, a troubling sign for Google's profit margin.

Source: Google Press Releases.

Google has been growing in part by its partner network driving more traffic to its domain. Given the recent trends in ecosystem usage, this should come as no surprise. According to technology and advertising provider Velti, which operates in 68 countries, Apple's (NASDAQ: AAPL  ) iOS devices made up 63% of ad impressions on its network, whereas Android only made up 37%. Given its 75% market share, I find it troubling that Android isn't the most used ecosystem on the planet. However, I find it more problematic that Google has to pay Apple for the right to have Google Search as Apple's default search engine. Multiply this example across all of Google's partners and it's easy to see how burdensome this can become.

Wide, but not deep
Perhaps this should be Android's slogan? Really though, there is a huge disconnect between Android's market share relative to its monetization base. As of November, Google Play's average daily revenue brought in $3.5 million, whereas Apple's App Store brings in $15 million on the daily. Last week, Apple's senior VP Phil Schiller bragged how Apple controls 75% of the smartphone industry's profit with only about a 20% market share. He's clearly taking a stab at Google, but the man has a point. Emerging-market users have yet to be app aficionados like more consumer-driven economies. The U.S., for instance, which happens to be the most important smartphone market, Android actually lags behind Apple's 53% market share by more than 11%. While Android may have expansive reach, it has yet to deliver on its promise by way of game-changing profits. It's entirely possible a significant share of Android users use their phones conventionally, which would completely undermine Android's entire business model.

Sell today?
First and foremost, I am a Google shareholder and this exercise helps to keep my expectations in check. Google's road ahead is perhaps more challenged than investors are willing to acknowledge, given its current near-perfection valuation based on historical earnings growth rates. Shares are trading at 23 times trailing earnings, roughly in line with its 24.5% five-year average earnings growth rate. Considering that shares have almost rallied back to where they were the day before Google reported last quarter, have investors grown convinced that this quarter will be an improvement from the last? I'm not certain about that answer, but I've certainly grown more cautious going into earnings on Jan. 22.

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  • Report this Comment On January 16, 2013, at 9:45 PM, deasystems wrote:

    Good article. In addition to all the negative factors mentioned, add Motorola: The acquisition so far has been nothing but a financial and management drain...

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