Exclusive Update
After spending a fair amount of 2012 in the market's dog house, Google regained investors' favor after its most recent earnings release, which triggered another run-up in its shares.
For the quarter and fiscal year the company reported the following results compared to the same respective periods last year:
Metric | Q4 2012 | Q4 2011 | Percent Change (YOY) | FY 2012 | FY 2011 | Percent Change (YOY) |
|---|---|---|---|---|---|---|
| Revenue | $14,419 | $10,584 | 36.2% | $50,175 | $37,905 | 32.4% |
| Operating income | $3,394 | $3,507 | (3.2%) | $12,760 | $11,742 | 8.7% |
| Net income | $2,886 | $2,705 | 6.7% | $10,737 | $9,737 | 10.3% |
Source: Google Investor Relations. Dollar amounts quoted in millions.
While relatively flat revenue might not seem like the kind of thing to reignite a rally, Google investors had plenty to be thankful for in this report. And understanding why requires looking at some of Google's secondary numbers.
If you had to distill Google's quarterly performance down to a single number, and be able to justify what's so positive about it, you'd likely chose "2%." That's the quarter-over-quarter change in Google's cost-per-click from Q3 to Q4. And why is that measly 2% so huge? Well, it signals that Google's mobile advertising conundrum might just have bottomed out.
As readers of this report should know, one of the chief anchors on Google's valuation has been its foray into mobile with its Android operating system. Investors have long been concerned by this dynamic, and it's certainly played a prominent role in limiting the multiple that investors were willing to value Google.
In one sense, investors should have lauded Google's entry into the space. It's the future of computing. And while desktop computers will always have some kind of presence in the 21st century, mobile has opened up a new medium for users to browse the Web (and most critically for Google, search the Web).
Google is of course, the supreme ruler of the search space. The Emperor. The Don. The undisputed king. No other company comes even close to threatening it in the search space. However, in order to maintain this lofty vantage point, Google needed to position itself for success on mobile as well. Fortunately for Google shareholders, it's done so masterfully.
As we know, Android is now the most popular mobile operating system in the world, and it's taking Apple to the woodshed in emerging markets. However, with the explosion of mobile-search volume became a problem for Google, although we think of it as a very good problem to have.
Because mobile devices feature smaller screens than conventional desktops, it became more difficult for Google to monetize its search ads on mobile devices. The equation is pretty simple and it goes something like this: Smaller screen size = smaller ads = smaller profits. It's not a perfect explanation, but it illustrates the basic scenario for Google.
Over the last several quarters, Google's seen this ugly dynamic play out. Investors have been waiting with bated breath to see when, if ever, this problem would stop. And as Q4 might indicate, Google might have just reached a bottom.
Metric | Q2 2011 | Q3 2011 | Q4 2011 | Q1 2012 | Q2 2012 | Q3 2012 | Q4 2012 |
|---|---|---|---|---|---|---|---|
| Paid-clicks growth (YOY) | 18% | 28% | 34% | 39% | 42% | 33% | 24% |
| Cost-per-click growth (YOY) | 12% | 5% | (8%) | (12%) | (16%) | (15%) | (6%) |
| Cost-per-click growth (QOQ) | 6% | (5%) | (8%) | (6%) | 1% | (3%) | 2% |
Source: Google Investor Relations.
Seeing cost-per-click, or CPC, notch a gain from last quarter certainly bodes well for Google's ad business. It could mean that Google has finally found a way to better monetize its mobile search traffic, which -- given the absolute explosion in overall searches -- could hugely benefit Google. Only time will tell, of course. But we did see some encouraging data that supports this notion. Several search marketing firms claimed that tablets were the most profitable category of search device in Google's most recent quarter.
Regardless, Google put up another great quarter. Our bullish thesis remains intact. We like Google's dominant positioning as the pre-eminent player in global search. Especially after stripping out Google's massive net cash balance, we believe Google remains reasonably underpriced by the market, trading at a low-to-mid teens EV/EBITDA multiple (a better measurement of cheapness given Google's massive cash hoard).
In short, Google remains a great buy today.
