Mixed Quarter from Google Obscures Value and Growth Profile

Google (GOOG) is trading down over 5% in a weak market (S&P down 2.2%) after reporting mixed 2Q10 results. The stock has given up most its gains in the past two weeks since the company received a new license to operate in China.

GOOG reported EPS of $6.45 on revenues of $5.1 billion net of traffic acquisition costs. EPS missed the consensus estimate by 7 cents although revenues were more than $100 million ahead of estimates. Revenues grew 23% and were up 1% from the first quarter. For many companies these results would have been good enough but GOOG is a high expectations stock with recently negative sentiment so a clean beat was necessary to sustain and build on recent gains.

The stock is suffering mostly because operating expenses rose more than expected resulting in a drag on profitability despite better than expected revenue growth. The Street has been concerned for some time that GOOG is facing a tougher competitive environment in which slowing top line growth was going to be met by investment in the business.

Second quarter results again showed heavy investment as GOOG defends its market share in search and invests in display advertising, mobile advertising and search, and YouTube. However, this quarter at least, GOOG's investments seem to paying off as revenue growth beat expectations and accelerated.

The other issue for Wall Street is that while GOOG grew EPS 21% in the second quarter, growth in the second half is expected to moderate into the mid to upper teens. Wall Street hates growth deceleration, especially from a growth company.

Looking ahead to 2011, the big question is whether growth can be sustained closer to 20% or continues to decelerate to 15% as implied by consensus estimates. The stock is undoubtedly good value at less than 15 times 2010 estimates adjusted for the huge cash balance. On 2011 estimates, the multiple is less than 13 times.

I think GOOG's long-term growth will be sustained at least in the teens as search is still growing and new areas are beginning to gain traction. As a result, I think the stock should be owned at current prices. However, the Street is going to need a positive surprise or at least a sign that investment spending is leveling off before the shares respond strongly. Given current valuation and initial signs that growth investments are beginning to pay off, I think it is worth waiting.

Disclosure: GOOG is widely held by clients of Northlake Capital Management, LLC inlcuding in Steve Birenberg's personal accounts. GOOG is a long position in the Entermedia Funds. Steve Birenberg is co-portfolio manager, partial owner the Funds' investment management company, and has perosnal monies invested in the Entermedia Funds.

Google Misses. Sort of.

Even before the Goldman Sachs related market meltdown, Google shares were down 5% following the company's 1Q10 earnings report after the close on Thursday. Most all of the many headline numbers regularly provided by Google met or slightly exceeded expectations. However, the upside was minor and there were a few blemishes. The upside was mainly a return to growth in paid searches. The downside was the price Google earned per search was a bit less than expected. Another blemish was that international growth ex the UK lagged. But since revenues came in slightly better than expected that means the US search business was above expectations.

I think Goldman Sachs' analyst nails it when he notes given a trade-off between more searches or revenue per search, he would take more searches. The implication is that the search business is still quite healthy despite the economy and challenges from mobile computing and the rise of Apps. The analyst also notes to be drawn from this mix is that US search growth accelerated big time. Given a choice between US and international search, he would take US as this market is supposed to be closer to maturity. Thus, a takeaway could be there is more upside abroad ahead than previously thought if the mature market is still growing at this rate.

I buy those arguments, which strongly suggest Google is fine for the intermediate to the long-term. The short-term is trickier as expectations were high and sentiment toward Google is mixed to the challenges on the business and regulatory fronts. Since Northlake's approach is to invest for months and years ahead, I will be holding the shares as I expect the long-term story will re-emerge later this year providing upside to $700. Based on 20 times 2011 estimates earnings plus projected cash on hand (currently over $85 and growing each quarter).

Disclosure: Google is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. Google is a long position in the Entermedia Funds. Steve Birenberg co-manages the Funds, owns a portion of the Funds' management company, and has personal monies invested in the funds.

Searching for Profits in Google

Earlier this week, I purchased a position in Google (GOOG) for all Northlake clients who use individual stocks as part of their portfolio strategy. GOOG pulled back from $630 in early January to $545 with the bulk of the drop occuring following the company's 4Q09 earnings report. A general correction in tech stocks and the possible loss of GOOG's growth opportunity in China also contributed. I see the pullback as an excellent buying opportunity. In 2010, upside exists from a cyclical upturn in advertising and the possibility of a return to China. Beyond 2010, I find the shares quite reasonably valued as GOOG continues its global growth in search, begins to gain material upside from its expansion in display advertising, and participates as an industry leader in mobile advertising. I see upside in 2010 consensus EPS estimates of $31. A 20 multiple on $33 in EPS equates to $660 offers 20% upside. Downside in the near-term, independent of a major market correction, should be modest given the stock has already dropped sharply.

Disclosure: GOOG is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. GOOG is held in the Entermedia Funds. Steve Birenberg is co-owner and co-manager of the Entermedia Funds and has a personal investment in the Funds.