Tuesday, 19 July 2011 15:47

Did A Blog Best Wall Street's Best of the Best In Gauging The True Value of Google? We Have To Think More Like An Entrepeneur & Less Like A Wall Street Analyst Featured

First of all, congratulations to all BoomBustBlog subscribers that have recieved windfall profits on their researched Google positions for the second time in less than a calendar year. Google traded down to a 4 handle as recently as a couple of weeks ago and the January 880 calls (which I kept in inventory) were trading as cheap as 5 cents each. As I type this, those same options last traded at $1.40 each (now down to 1.05)- that's a 21x-26x return! 

Google's latest quarterly results should lead many - if not most - to believe Reggie Middleton and his team at the BoomBust bests ALL of Wall Street's sell side research. For previous examples (a lot of them), reference Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

It is now well known that Google has once again knocked the ball out of park with their performance. Those who follow my blog know that I have been bullish on Google since the spring/summer of last year, with signfiicant profits being taken along the way. Many on the Street have turned rather negative on Google despite some of the most positive results and promising actions of its history, and in the industry! Why is that? How did I see so much value in Google while the Street was remiss, only to be taken totally and utterly by surprise? Let's take a historical traipse of my take on Google, but first we peruse the "short term-ities", looking forward only three months at at time mentality of Wall Street to ascertain why only Reggie Middleton's BoomBustBlog screamed on the The Gross Misvaluation of Google. [Subscribers, please follow along with the subscription documents - Google Q1 2011 earnings review - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google and the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).]

Larry Page did an excellent job on his first full debut performance as Google's new CEO during the conference call. One of his most important accomplishments? Convince the Wall Street crowd to realistically look at value creation and look away from short term, quarterly this-and-that-itis. A true high growth company is willing to sacrifice some margin to grow the business. This is Page on one of the most recent ventures, Google+:

I see more opportunities for Google today than ever before, because, believe it or not, we are still in the very early stages of what we want to do. Even in search, which we have been working on for 12 years, there has never been more important changes to make. They said there is no money to be made in search over and above a bit of banner advertising. Most new Internet businesses have had that same criticism. Fast-forward to today. It feels like we are watching the same movie again in slow motion. We have tremendous new businesses being viewed as crazy — Android. And actually have a new metric to report in Android of 550,000 phones activated a day. That is a huge number, even by Google’s standards. Chrome is the fastest growing browser. We have over 160 million users. Now people rightly ask, how will we monetize these businesses? Of course, I understand the need to balance the short-term with the longer-term needs, because our revenues and growth serve as the engine that funds our innovation. But our emerging high usage products can generate huge new businesses for Google in the long run, just like search. And we have tons of experience monetizing successful products over time. Well-run technology businesses with tremendous consumer usage make a lot of money over the long term.

Google+ is most likely a game changer and definitely has hurt those Goldman clients who allowed the Squid to convince them to fork over all of that money in a private offering, ex. Did Goldman Just Rip Its HNW and Institutional Clients Once Again? Facebook Growth Slows Pre-IPO, Just As We Warned! (more on that in a post later on today).

Google is a very aggressive Internet investment company who just so happens to operate its investments. Thus, it is a strategic acquirer. The problem with that, and the reason that there was a "Gross Misvaluation of Google" is that the Street cannot fully appreciate strategic investment when their entire world is measured 3 months at a time!!! In reference to aggressive investment, Page said:

Overall, we are focused on long-term, absolute profit and growth, as we have always been. And I will continue the tight financial management we have had in the last two years, even as we are making significant investments in our future. I would like to finish on our people. Great companies are no greater than the efforts and ingenuity of their people. We are continuing to hire the best. Keeping them happy and well-rewarded is crucial to our future. Many of you will be interested in hiring, whether we hired a few hundred more or less than you expected this quarter. But we will optimize headcount for the long term and the opportunities we see. It’s easy to focus on things that we do that are speculative, e.g., driverless cars. But we spend the vast majority of our resources on the core products. We may have a few small speculative projects happening at any given time, but we are very careful stewards of shareholder money. We are not betting the farm on this stuff.

Has Google given investors a reason to believe in Page's diatribe?

Reference the BoomBustBlog post, A Realistic Look At The Success Of Google's Investment History

As promised, I am presenting historical justification of the logic behind my call of absurdity in the drastic drop in share price after Google announces a redoubled effort in investment and marketing of its nascent businesses. I went into the logic in detail via our Google Q1 2011 earnings review - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google. The following pages are excerpted the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).

To begin with, Google apparently realized early on that it could better realize returns by investing shareholder capital through acquisitions. It has actually been quite acquisitive, making 88 purchases over the last 13 year. Last year was Google's most acquisitive year, ever!

While many of the referenced acquisitions have been to bolster existing products, several have literally become home runs - rising to the top of their respective categories and even threatening to go farther in that hey have the distinct potential to creatively destroy the status quo of several multi-billion dollar industries. Let's walk through a sampling.

Doubleclick + Youtube + Google TV (organically grown)

This combination is probably the closest thing to a direct replacement for TV as we know it. Even if Google TV does not succeed, YouTube is currently the most watched video site, by far and Doubleclick (for monetization, along with adsense style ads) is the 2nd largest display ad entity. Again, the potential to reconfigure the TV industry. Google is already seed funding original content and cutting licensing (streaming rental) deals with the large established studios. The ability to threaten TV as we know it was purchased for just over $1 billion. A pretty good investment, no? Would the NY Times parent co., Fox, Disney, NBC/Universal have considered this a wise purchase?

Admob and Android

For a mere $250 million (plus ongoing support and development costs and investments), Google now commands the largest global footprint of mobile phone OS, the fastest global mobile phone OS growth rate, the largest (by a very, very wide margin) mobile ad presence, and inarguably the most disruptive force in mobile computing. What tech, media, telecomm or strategic investment company would NOT by the Android/Admob combo now for 10xor eve 15x what Google paid for it? Microsoft, Nokia, Apple, Samsung, LG, RIM, Oracle, IBM, HP, anyone???

The list of strategic acquisitions that have paid off in spades goes on, as well as the requisite flops that go along with a high volume strategy.

So, assuming that Google has done a good job at spending its shareholder's money and sprouting several billion dollar businesses to assist in the diversification away from pure web search advertising - and realizing that last year was Google's most acquisitive to date, and realizing that Google is dumping more money into research, marketing, headcount and acquisitions now than in any time in its existence (including last year), should you be bullish on the stock? Three or four more Androids, YouTubes, Admobs and Doubleclicks to disruptively take over 5 or six more multi-billion dollar industries is a reason to lop 15% off of this stocks price (which currently barely accounts for just the search engine potential)???

As excerpted from Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google:

For the quarter ended March 31, 2011 Google reported gross revenues (before traffic acquisition costs) of $8.58bn, an YoY increase of 26.6% and QoQ increase of 1.6% while net revenues (after traffic acquisition costs) increased 29.1% YoY and by 2.6% sequentially to $6.54bn. The YoY growth in gross and net revenues was the highest at least since 2008 demonstrating a increasingly momentum in the growth of Google’s digital ecosystem. The increase in net revenues (after TAC) was actually stronger than the increase in gross revenues, indicating that Google has not only packed in growth but lowered aggregate top line expenses.

 However, despite a strong set of results the stock took a severe beating and was down c8% as the results were short of analyst expectations. The market’s reaction to Google’s numbers clearly reflects the very myopic view of US public markets wherein a stock is dumped if it fails to beat consensus – even when this view clearly overlooks the broader picture.

Google’s adjusted earnings came in at $8.08 a share below the $8.17 expected by the markets. However, a closer look at the results reveals that the perceived shortcoming was not a result of a revenue miss or margin compression but on account of Google’s entrepreneurial (and quite applaudable – at least from this investor’s perspective) endeavor to invest heavily in future projects. The miss was principally due to higher research and development expenses as the company continues to invest in new emerging businesses like Display, Mobile and Enterprise. Research and development expenses (including stock based compensation expenses) grew 50% YoY to $1.2bn and was 14.3% of gross revenues in Q1 2011 vs. 12.5% in Q4 and 12.1% in Q1 2O10. Had research and development expenses at 12.5% of gross revenues, the earnings would have been $8.51 per share, a clear beat to consensus and stock would have seen a roller coaster ride – despite the fact that future prospects would have been a fraction of that they are now due to lower investment in the future. Google has proven that their investments yield superior returns to that of cash holdings, ex. Youtube, Android, Admob, Google Voice, Teracent, etc. Instead, the stock was pushed down 8% as the shorter term players in the market reacted. Players such as sell side analysts whose employers benefit from the shorter horizon churning of stocks vs. a longer horizon and outlook, and traders who act on price movement and not value, were(are) clearly tangled between web of OPEX (ongoing cost for running a product, business, or system) and CAPEX (expenditures creating future benefits).

You see, the Street has become so accustomed to playing the earnings management game with their favored companies that most of them have actually lost the ability to ascetain true value outside of quarterly accounting earnings! Case in point - Apple's valuation

As excerpted from

Yes, we are more optimistic on Apples' earnings than the sell side (reference page 16 in subscription document File Icon Apple - Competition and Cost Structure) Look to my writings from last summer to determine the common sense reasons why: .

No, Google is not in the mobile space for search ads, it's looking to become the next Microsoft with Android as the next Windows. It is thinking big, simultaneously going after both the consumer and the enterprise space with cloud-based software and services - and advertising!

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don't get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the "Sheeple" retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this - If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter - for 11 quarters straight, shouldn't you fire said analysts for incompetency in lieu of celebrating Apple's ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no - actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why...

Of course, this inability of the Street to see the forest for the trees magically stops at the retail and insitutional customer. Once it comes to its own accounts, the Street miraculously start's to agree with Reggie's analysis... Miraculously! Reference: Goldman Sells Nearly Half $Billion Of Apple Stock Directly Into Their Client's Conviction Buy Recommendation: Guess Who Really Agrees With Reggie Now! and read very carefully!

Since I started covering mobile technology on BoomBustBlog, things have pretty much occurred precsiely as we anticipated - with Google, Microsoft, and Research and Motion (a 6x to 7x gain on select puts) following their prescribed paths...

Next up is Apple, whom we predicted our analysis would reach frutition in the 4 to 6 quarters. Apple reports today, and we fully suspect a blow quarter that (again, just like the last 12 quarters) surprise the unsurprisingly inept analyst estimates that somehow could not get it right for nearly 2 years straight see above). We also expect indications of our margin compression thesis to start peeping their little eyes out of the footnotes, of course to be totally ignored by the cheerleading sell side of Wall Street and pop tech and financial media, as the Apple lovefest marches on.

Last modified on Thursday, 20 October 2011 13:40

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