Google Watch

We’re less than two weeks away from Google’s (GOOG) next earnings report and I’m starting to sense some nervousness about the stock. I can’t even pretend to forecast Google’s business, but I can judge its management, This company isn’t merely “insensitive” to its shareholders, it’s actively hostile.
The WSJ has an interesting article this morning on Google’s increasing use of stock options and restricted stock. When your stock is soaring, this seems like free money to pay your employees, however, the bill will eventually come due:

But few investors are focusing on the growing number of restricted shares and options that Google is handing out to employees, which will emerge as a sizable expense in the next few years. That expense added up to a hefty $600 million or so as of Sept. 30 of last year, all of which will be charged against future earnings.
As Google’s business grows and it courts employees in a competitive marketplace, it is picking up the pace of its issuance of “performance-based stock units,” according to securities filings, a form of compensation that many investors overlook. Between March 31 and Sept. 30 of last year, Google gave out 498,000 units, a close cousin of stock options, which likely will convert into Google shares over a four-year period.
The units are valued at the price of Google shares at the time they are granted. Since the average stock price was about $300, the units represent an expense of about $150 million. Because the units vest over four years, accounting rules require the company to count one-quarter of their cost as an expense each year. So, Google took just $8.9 million of expense for the units during the second and third quarters. The remaining cost will hit earnings over the next few years.

This past weekend, Floyd Norris looked at the valuation comparisons between IBM (IBM), Berkshire Hathaway (BRKA) and Google.

If Google were to now trade at the same multiple to historic revenue that Yahoo does, it would lose nearly half its value. If it traded at the same multiple to historical earnings, it would fall around 65 percent.

On Tuesday, Scott Kessler at S&P did the unheard of. He downgraded Google to a “sell.” He told Business Week that he’s concerned about Google’s growing risk:

What are the risks that Google faces?
I think investors should know the ABCs of Google risk. “A” is for the absence of material revenue diversification. As good a company as Google is, it still generates 99% of revenue from one source: Internet search advertising.
“B” is for building competition. Yahoo! is investing aggressively in search. It is No. 2 in the Internet search-advertising area and is doing its best to compete. Microsoft is slated to introduce adCenter in the second half of 2006. This will launch the company into Internet search advertising.
We do think that Microsoft’s entry into this category is going to have an impact. In addition, Ask Jeeves, which was acquired by IAC/InterActiveCorp last summer, says it will pursue a proprietary Internet search-advertising strategy.
Last but not least is Fox Interactive Media. This was created in mid-2005 by News Corp., and includes MySpace.com, which has become an extremely popular destination for teens and twentysomethings. This is not speculation that Fox Interactive Media will pursue Internet search — its executives have said they will do this. The question is how they will do it, either via acquisition or partnership. We don’t expect it to partner with Google.
Getting back to the ABCs of Google risk, “C” is for click fraud. This is relatively unknown to most Internet users and investors. It’s relatively simple. A recent study suggests that up to 30% of online clicks could be fraudulent — meaning not authentic, or not consisting of real users delivering clicks. We’re talking about synthesized clicks by people or a box that automatically rings up clicks that benefit Internet search companies like Google.
We think this problem is more pervasive than people think. We think it will affect advertisers’ taste for Internet advertising and the prices they are willing to pay for ads. And this could have a negative effect on Google.
So, essentially, my downgrade of Google is about valuation and risk. The stock is up 450% since its August, 2004, debut at $85 a share. We think there are notable risks to the stock, and investors should take action based on them.

Posted by on January 19th, 2006 at 10:36 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.