Friday, 19 October 2012 10:08

Reggie Middleton's Observations on Google's Dramatic 3rd Quarter 2012 Earnings Release Featured

Below are my thoughts, but before I get into them I will like to reiterate that many pundits, investors, analysts and traders still have no clue as to the type of company that Google is. Imagine a private equity firm that has consistently put out the leaders (as in the number one company) in several industries, every 3rd year or so for 10 years straight. Now, take that private equity fund and give it it's own operations with some of the smartest engineers and strategists in the world, and have them spend 1.5 Billion (that's Billion with a "B"") in R&D annually to discover new things. Now fund that private equity fund and R&D camp with cashflow from the world's largest automated web advertising firm, whose closest competition is so far away as to barely even be known for its wares by the average person. Now, add to it the worlds fastest growing, largesta and most technically advanced mobile operating system. Then add to it the largest patent portfolio and 4th largest handset maker in the world (remember the mobile industry is where its at now). Then add to it the largest and by far the most prominent digital media destination AND publsihing property in the world. Then add to that the largest consumer and enterprise cloud operations in the world. 

Finally, add to the mix the largest, most oft use and most entrenched search engine which (when combined with the cloud properties) basically makes this company the defacto gatekeeper for digital data for the world.

What would you have with this new world conglomerate? You'd have Google, that's what you'd have. Now, on to my anecdotal quips on Google's dramatic Q3.

  • Enterprise wide margins have dropped. I suspect the Motorola acquisition and the influx of mobile revenues, which alter the supply-demand landscape dramatically, thus dropping pricing power for the near to medium term. 
  • Core site revenues are growing along trend line
  • International growth is healthy, though hampered by FX hedging losses
  • Paid clicks increased 33% YOY while costs per click decreased 15% over same period - core margin expansion!
  • Traffic acquisition costs are up 8% YOY - paying more for traffic, but less than margin expanding...
  • Motorola revenues are material, and their margins are weak which pulls down overall margins. This is a foreseen negative but management obviously feels it is worth it, likely due to the largest patent portfolio in the business, the 2nd largest set top box position in the industry and the 4th (roughly) best handset manufacturer in the industry. I'll side with management on this one.
  • "Other costs of revenues" more than doubled YOY, which should be a major cause for concern. As a matter of fact it is such a large increase as to be akin to one-time events. These need to be investigated in detail.
  • The key determinant of the value of this quarter's numbers is whether these increased expenses are (in increasing value from very bad to potentially very good):
    1. 1. - Recurring expenses signaling a structural change in the business
    2. 2. ~ Onetime expenses
    3. 3. + Investments in future revenues inaccurately characterized as cost and expense.
  • My bets are that those algo traders and armchair pundits masquerading as investors and analysts are overlooking strategic investment and calling it expense. A glimpse into the EDGAR filing’s cash flow quip reveals some clues: “Cash Flow and Capital Expenditures – Net cash provided by operating activities in the third quarter of 2012 totaled $4.0 billion, compared to $3.95 billion in the third quarter of 2011. In the third quarter of 2012, capital expenditures were $872 million, the majority of which was for production equipment and facilities-related purchases. Free cash flow, an alternative non-GAAP measure of liquidity, is defined as net cash provided by operating activities less capital expenditures. In the third quarter of 2012, free cash flow was $3.13 billion. We expect to continue to make significant capital expenditures.

You heard it direct from the horse’s mouth! Despite heavy infrastructure and development expenditures, plus the biggest acquisition ever, Google increased free cash flow. Google will make a significant push into original digital media and content. Expect YouTube to compete directly with NBC, FOX, HBO, etc.

Risky? Yes!

Potentially profitable and disruptive? Ask the classified and newspaper industries (or at least what’s left of them) if Google knows what it’s doing!!!!

As excerpted from our nearly 70 page forensic Google report (Subscribers, see Google Final Report 10/08/2010), I attempt to educate on the investment prowess of Google (that is both internal investment and external acquisition). Remember, many of Google's investments have become the largest instances of their type in the indsutry. The largest web video presence: YouTube! The largest mobile OS? Android! The largest mobile ad presence? Admob! the largest online productivity suite? Docs/Drive! I can go on with Gmail, Voice, etc., but if I haven't driven the message home yet then I probably never will. Google management has made it clear that YouTube will compete with major networks and Google Docs will compete and is actually pulling some business from Microsoft Office in the Enterprise. These are mere anecdotal examples. We all know the Android story already...

Google Final Report Sep 29 Page 49

Google Final Report Sep 29 Page 50

Google Final Report Sep 29 Page 51 

Google Final Report Sep 29 Page 52

Google Final Report Sep 29 Page 53

Google Final Report Sep 29 Page 54

Industry Leading, Subscription Based Google Research

All paying subscribers should download the Google Q1-2012 Valuation Summary, wherein we have updated the valuation numbers for Google using a variety of metrics. Click here to subscribe or upgrade

Google still exhibits the likelihood that they will control mobile computing for the balance of the decade.

Subscription research:

file iconGoogle Final Report 10/08/2010

A couple of bits from our archives...


There are currently 7 Google reports available. Select the "Google Final Report" and click the "Download" button. You will receive a 63 page analysis that looks like this on the cover...

The table of contents outlines how we have broken Google down into distinct businesses and identified both the individual business models and the potential revenue streams, as well as  valuation for each business line.

Page 57 of the analysis shows a sensitivity table which outlines the various scenarios that can come into play and how it will change our outlook and valuation opinion.

Professional/institutional subscribers can actually access a subset of the model that we used to create the sensitivity analysis above to plug in their own assumptions in case they somehow disagree with our assumptions or view points. Click here for the model: Google Valuation Model (pro and institutional). Click here to subscribe or upgrade.

Finally, let's look at Google today compare to the broad market over the last 6 months...

goog stock price vs sP

'Nuff said!

Last modified on Friday, 19 October 2012 11:39

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