Monday, 08 November 2010 11:19

Google's 3rd Quarter Operating Results: The Foregone Conclusion That Was Amazingly Unanticipated by the Street!!!

Summary: A full analysis of the grand slam Q3 earnings performance that was anticipated in full detail by BoomBustBlog, yet took the Street by surprise.

Google hit the ball out of the park with their latest earnings release, yet I feel the gist of their success is missed by many. Although Google was able to increase revenues and profits on expanding margins (a win, win, win situation), what is most impressive is that they were able to do it while simultaneously investing in very high risk/high reward ventures. Google TV, Android, YouTube and AdMob are the ones that come immediately to mind. Android alone threatens to, and actually is, disruptively transform the entire ultra mobile and mobile computing space. The potential of Android coupled with Google's ad revenue subsidy prowess and plethora of cloud services is not only quite formidable but obviously the wave of the very near future - a future that Google is more apt to dominate than most of the technology powerhouses of today.

On that note, I am releasing the File Icon Google Q3 2010 review for all paying subscribers (click here to subscribe):

As is customary, I am excerpting a generous swath of the subscription report (sans updated valuation) for free distribution on the blog...

Google Q3 results

For the quarter ended September 30, 2010 Google reported gross revenues (before traffic acquisition costs) of $7.29bn, an YoY increase of 22.6% and QoQ increase of 6.8% while net revenues (after traffic acquisition costs) increased 25% YoY and by 7.7% sequentially to $5.48bn. These results clearly demonstrate decoupling of digital economy vis-à-vis the real economy, or put more aptly, the wholesale movement of traditional marketing and advertising to that of the Web-based variety.

Google continues to be a reckoning force in the online search market commanding almost two-thirds of worldwide search queries. In Sep 2010 Google’s share of core search queries was 66.1%, the highest since January 2009. Despite commanding over 60% of market share the company continues to expand its share of search.  After a slight blip in May and June, the share has increased for four straight months in a row.

All the three reporting segments and geographies delivered strong growth rates during the quarter. Google website (66% of total) revenues increased 22.2% YoY and 7.4% sequentially to $4.8bn while Google Network Revenues (AdSense, 30% of total) increased 22.1% YoY and 6.6% sequentially to $2.2bn and Licensing & other revenues increased 34.9% YoY to $254m. In terms of geographic split, both US revenues (48% of total) and RoW (41% of total) grew 26%) and UK (11% of total) witnessed revenue growth of by 10% (19% organic growth offset by negative currency movements).

Total cost of revenues increased at a slower pace compared with revenue growth positively impacting the margins. Total cost of revenues excluding stock based compensation expenses (which includes Traffic Acquisition Costs) grew 15% YoY to $2.5bn (35% of gross revenues in Q3 2010 vs. 37.2% in Q3 2009). Traffic Acquisition Costs grew 16% during the quarter to $1.8bn (or 25.7% of advertising revenues) compared with $1.5bn in Q3 2009 (or 27.1% of advertising revenues). Cost per click increased 3% YoY and 2% QoQ. Research and development excl stock based compensation grew 33% YoY to $750m and stood at 10.3% of revenues versus 9.5% in the previous year. Sales and marketing expenses excl stock based compensation increased 35% YoY to $586m, or 8.0% of revenues in Q3 2010 vs. 7.3% in Q3 2009 while general & administrative expenses excl stock based compensation increased 39% YoY to $479m, or 6.6% of revenues in Q3 2010 vs. 5.8% a year ago. Stock based compensation increased to $380m (5.2% of revenues) from $318m (5.3% of revenues) in Q3 2009. Overall, income from operation increased 23% YoY to $2.5bn with operating margin of 35%. However, due to lower tax rate (20.2%) net income increased 32% YoY to $2.2bn, or diluted earnings per share of $6.72 over $1.6bn in Q3 2009, or diluted earnings per share of $5.13. Adjusted dilutive earning per share (adjusted for stock based compensation) was $7.48 in Q3 2010 compared with $5.90 in Q3 2009 and $6.45 in Q2 2010.

The BoomBustBlog Investment Thesis Remains Intact

As highlighted in the Google forensic report, our key investment thesis for our bullish view on Google includes:

  • Secular mix shift from offline to online ad spending, and Google with c67% share in search market is set to benefit enormously from the secular mix shift though growth in search ad spend (ad words)
    • We had meticulously demonstrated the case for several of the next multibillion dollar business lines after search in the form of display, mobile and other emerging business.
  • o   Increase  in share of display revenue as Google which currently lags Yahoo in display is ramping up its efforts through YouTube monetization, the DoubleClick acquisition and Teracent acquisition
  • o   Opportunities in wireless search as Google goes mobile with Androind and AdMob. The success of Android coupled with Google’s traditional dominance in search advertising has laid a solid foundation for Google to thoroughly monetize the opportunity in the mobile space.
  • o   Potential premium free call options on several new multi-billion revenue opportunities in the form of Google TV / Google Voice / Google Cloud Computing (for details refer to Google Forensic report)
  • Bolt-on acquisition strategy

Given our investment thesis, Google’s consensus beat in Q3 was hardly a surprise to us at We have been persistently arguing for higher share of display and mobile space. In Q3 revenues annaulised revenues from display segment were $2.5bn with total revenues of $625m for the quarter with revenue share of Q3. Mobile revenues at annualized rate were $1bn, or $250m for the quarter with revenue share of 3.4% in Q3. We believe these numbers put a definitive end to the argument on whether or not Google would be able to successfully monetize Android on which we had spent considerable ink in our Forensic report. We were however pleasantly surprised at Eric Schmidt response during earnings conference call when he mentioned that mobile space has potential to outgrow that of the PC market – a view which Reggie Middleton has espoused consistently!

Eric Schmidt, CEO of Google:

It would be I think premature to – for us to estimate what that would be, but if you assume that search monetization on handsets will become equivalent to PCs and then eventually exceed it, which is my personal view, then it should be highly lucrative, because those – the customers that are using Google services, they are going use it more because they are more personal and more targeted. And so ultimately, it should be a very, very strong revenue stream compared to a PC.


At current price ($625) Google has already reached our base case target price of $630 (which would have given handsome returns of 20% since we released the report (and a return of 35% when we first mentioned about long opportunities in Google when it as c$470). However, unlike sell side analysts who change their target price post math the share (studies show that actual share price is leading indicator of sell side target price contrary to the logic that target price should be leading indicator of actual price) we reiterate our base case valuation of $635 (marginally up from $630 previously as a result of stronger-than-expected Q3). As a reminder, our sell side target price of $595 reflected Google’s fair value including online ad spend (display and search) and mobile while our base case fair value of $635 reflected sell side valuation plus base case valuation of  Google TV, Google Cloud and Google Voice (assuming nominal returns from each of the returns). That is, at $625 we believe the current price fully reflects above opportunities. However, if one were to assume success of Google TV, Google Cloud and Google Voice the stock could potentially reach...

The balance of this quarterly report is available here File Icon Google Q3 2010 review for all paying subscribers (click here to subscribe or upgrade). For those wondering how the two first technology reports released fared in terms of performance, please see below (and keep in mind that we were contrarian on all of these calls at the time of initial publication)...

[caption id="attachment_3950" align="alignnone" width="640" caption="A recent, 1 month snapshot of Google medium term calls, up nearly 350%"][/caption]

Excerpted from (the must read) A Quick Peek Into the REAL WORLD Logic That Went Into Building the BoomBustBlog Apple Model: It’s Called Compression!!!:

So, following up on the piece that I did just a few hours ago – Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He? along with this cute chart…

Excerpted from BoomBustBlog Research Hits Another One Out the Park! Google up nearly 10% after hours, true blowout earnings unlike JPM:

Google is seeking new revenue streams, including searches on mobile phones. Its Android software has surged in popularity among consumers, overtaking Research In Motion Ltd.’s BlackBerry to become the top smartphone operating system in the U.S. in the second quarter, according to research firm Gartner Inc.

Display advertising at Google is growing as its YouTube video-watching service attracts more marketers. The company said in May it had boosted the number of display advertisers 10-fold on YouTube.

“Our newer businesses — particularly display and mobile — continued to show significant momentum,” Chief Executive Officer Eric Schmidt said in a statement.

Display revenue is on pace to top $2.5 billion annually, Jonathan Rosenberg, senior vice president for product management, said on the conference call. Mobile-ad sales are on track to exceed $1 billion annually, he said.

This is pretty much verbatim as we predicted it, and the stock and option prices are performing accordingly…

And on the short side, as excerpted from The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download:

I strongly urge all paying subscribers to read and reread the longest forensic analysis that I have ever released (@63 pages): File Icon Google Final Report, as well as the File Icon An Analysis and Valuation of Google’s Android and AdMob. Professional subscribers are strongly urged to play with all of the market and valuatin models that we have to offer (click here to subscribe):

This carries on with the strong performance of the Research in Motion Analysis, which I am now giving away for free since it has hit our initial price point and generated very satisfactory profits via a mix of puts and shorts as well, see The Research In Motion Forensic Valuation and Analysis is Released to the Public... There may be an update to this report in the near future, and if the landscape makes a material change. For a full backgrounder of my thoughts in this space, see below...

The Creatively Destructive Pace of Technology Innovation and the Paradigm Shift known as the Mobile Computing Wars!

  1. There Is Another Paradigm Shift Coming in Technology and Media: Apple, Microsoft and Google Know its Winner Takes All
  2. The Mobile Computing and Content Wars: Part 2, the Google Response to the Paradigm Shift
  3. An Introduction to How Apple Apple Will Compete With the Google/Android Onslaught
  4. This article should drive the point home: 
  5. A First in the Mainstream Media: Apple’s Flagship Product Loses In a Comparison Review to HTC’s Google-Powered Phone
  6. After Getting a Glimpse of the New Windows Phone 7 Functionality, RIMM is Looking More Like a Short Play
  7. RIM Smart Phone Market Share, RIP?
  8. Android is gaining preference as the long-term choice of application developers
  9. A Glimpse of the BoomBustBlog Internal Discussion Concerning the Fate of Apple
  10. Math and the Pace of Smart Phone Innovation May Take a Byte Out of Apple’s (Short-lived?) Dominance
  11. Apple on the Margin
  12. RIM Smart Phone Market Share, RIP?
  13. Motorola, the Company That INVENTED the Cellphone is Trying to Uninvent the iPad With Android
  14. Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space
  15. More of the Android Onslaught: Increasing Handset Revenues and Growth
  16. The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download
  17. The Complete, 63 pg Google Forensic Valuation is Available for Download
  18. iSuppli Continues to Validate BoomBustBlog’s Original Thesis: Android as the Viral Game Changer!
  19. BoomBustBlog Research Hits Another One Out the Park! Google up nearly 10% after hours, true blowout earnings unlike JPM
  20. As I Warned in June, DO NOT DISCOUNT Microsoft in This Mobile Computing War! Their Marketing Campaign is PURE GENIUS! and it Appears as if the Phone Ain’t Bad Either
  21. Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He?
Last modified on Monday, 08 November 2010 12:49


  • Comment Link shaun noll, CFA Tuesday, 09 November 2010 10:50 posted by shaun noll, CFA

    I think ABK's issues were for casted and then the stock barely moved initially once it was announced. Different parts of the ABK capital structure were pricing in different outcomes for sure though. Ultimately though they went down due to a cash flow issue and cash flow claims so while I 100% agree there are capital shortages I think it comes down to cash flow to try and predict who is going under in the short/medium term.

    by the way, love the tech analysis/research lately, in a stagnant global economy it is difficult to find growth companies and you have a great track record in tech so fun to watch you dig into these companies.

  • Comment Link Reggie Middleton Tuesday, 09 November 2010 02:35 posted by Reggie Middleton

    I'm going to spend some time addressing this today, Tuesday. I've been offline for much of Monday. Basically, many of the positions should have been unwound from Ambac, although I doubt that they have. The more telling issue is that ABK's BK was a matter of simple fundamentals, which the market has forgotten to trade off of these days. The forces that drove Ambac into BK, are there for MBIA, Fannie and Freddie Mac as well as the big banks. There is not enough capital in the system to cover the losses. Fannie, Freddie and AIG have sucked up c.$500 billion in just aid! The hole is deep and wide, yet the fundamentals have been ignored. From what I have heard (I was away from a quote screen) ABK's share prices didn't even move in tune with the BK announcement until after the market close.

  • Comment Link shaun noll, CFA Monday, 08 November 2010 16:51 posted by shaun noll, CFA

    Hi Reggie,

    looks like ABK finally kicked the bucket, would be interesting to get your thoughts on if this has any impact on the banks capital levels since anything insured by them is now clearly worth much less.

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