Doomsday for the Search Engine Giant

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Google (NASDAQ: GOOG) the search engine giant is expected to announce its earnings today, after market close. All sorts of comments are being heard in the market. Some are selling Google’s shares on its poor investment decisions in non-core businesses. However, others believe Google is one of the cheapest stocks in the Internet paradigm. What to believe?

The investment case

Within the U.S. Internet space, Google (NASDAQ: GOOG) seems to be an attractive buy. The cost-per-click (CPC) trends are expected to improve over time. Google also continues to benefit from very strong paid click growth. In addition, the strength of Google’s Android platform (over 72% global market share according to Gartner) positions the company to capitalize on mobile disruption and to benefit from the increased usage of Google products (Search, YouTube, and Mail). Google is a very strong player in Display and Video, via the DoubleClick Ad Exchange, Google Display Network, and YouTube. As Google continues to benefit from the structural growth of Internet usage globally and global macro concerns ease, we believe the market will recognize its strong fundamentals and its position as the leader in online advertising.

The business drivers

Google’s core business remains search, and we expect this business to maintain continued strong growth. We believe CPC trends will improve over time owing to 1) moderating F/X headwinds; 2) emerging market pricing firming; and 3) improvement in the monetization of mobile CPCs aided by increased e-commerce activity on mobile devices. We believe Google will benefit from continued strong paid click growth (+33% Y/Y in Q312) due to the proliferation of mobile devices and growth in Internet users internationally.

Mobile CPCs

The third point needs some more discussion. It is important to note that the mobile shopping boom has brought increased traffic to many companies. Internet radio player, Pandora (NYSE: P) is a super example of this fact. The company’s music-streaming app has witnessed a 47% YoY increase in traffic this year. However, it has to be kept in mind that this growth is not as much beneficial for these companies as understood by the public. Pandora gets hardly 40% of the revenue it derives from a desktop listener.

On a similar note, Google’s average CPC fell by 15% in the last quarter as the increase in mobile-based searching shifted the revenue mix and pressured gross margin. However, some companies have benefited from this trend as well. Facebook (NASDAQ: FB), the social media giant, has surpassed 600 million users in the mobile space. No wonder why analysts  were convinced to increase the company’s revenue and EPS estimates. However, the company is only getting 14% of ad revenue from mobile users, which means that there is still massive room for an increase in ad revenue from this channel.  

‘Back to Google’

Google is also very strong in display advertising. The company is experiencing an acceleration in its Network Web Sites revenue, which includes its AdSense display advertising business, and it maintains a dominant position in the growing online video advertising market via YouTube.

Upside/downside scenarios

Google has solid prospects for growth in search as multinational advertisers continue to ramp online ad spend and could see upside from continued growth in business segments such as display, video, and mobile. Google’s upside scenario means a price of $875 based on a 2013 multiple of 19x and an EPS estimate of $46.35.

A macro advertising slowdown, large-scale investments by Google in unprofitable non-core businesses, and the MMI acquisition could negatively impact investor sentiment, valuation, and profitability. Google’s downside scenario could see a price of $640 based on a forward multiple of 14x and an EPS estimate of $46.35.

Valuation analysis

There is significant opportunity in Google as it currently trades at 15.1x which is among the lowest in the Internet universe and toward the low end of its historical valuation. Google continues to grow its core business revenue at over 20% y/y and has some of the strongest operating margins in our universe. Barclays has set a price target of $800 which is based on a forward multiple of 17.5x and an EPS estimate of $46.35.

AnalystX has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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