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Google earnings to shine on search ads

Analysts predict strong third-quarter numbers--but some warn that its stock is overvalued.

Stefanie Olsen Staff writer, CNET News
Stefanie Olsen covers technology and science.
Stefanie Olsen
4 min read
Financial analysts are predicting strong third-quarter earnings for Google on growth of search-related advertising, but some caution that its stock is still overvalued.

The Mountain View, Calif.-based search provider will report earnings for the first time as a public company after market close Thursday. Financial analysts are projecting that it will earn 54 cents a share on revenue of $456 million in the third quarter, according to a consensus of analysts surveyed by Thomson First Call.

"One of the reasons we expect the third quarter to be strong is because international search was better than expected this quarter, bucking seasonal trends," said Marianne Wolk, an analyst at Susquehanna Financial Group.

But because the company has offered little guidance to Wall Street, as Google's founders stated in its IPO prospectus, the range of expectations still varies widely. Analysts' estimates on revenue range between $440 million and $474 million for the quarter, according to First Call.

At least one research firm believes that Google's stock is overpriced, based on its earnings per share growth rate from 2004 to 2005. "On a price-to-earnings ratio...we value Google's stock at $100 based also on a 20 percent discount to Yahoo's current valuation," financial analyst Martin Pyykkonen of Janco Partners wrote in a research note.

Since Google's initial public offering in August, which raised about $1.7 billion, its shares have shot up from about $95 to Wednesday's closing price of $140.49. That gives the company a market cap of about $38 billion.

Analysts said they expect Google to follow Yahoo's lead when it comes to growth in commercial search, the hottest sector of the rebounding online advertising business.

Rival Yahoo reported last week that its quarterly profit more than tripled from the previous year, buoyed by online advertising and its buyout of commercial search specialist Overture Services. Yahoo reported net income of $253.3 million, or 17 cents a share, in the third quarter. That's compared with $65.3 million, or 5 cents a share, in the same period in 2003.

Several analysts calculated from Yahoo's earnings that its revenue from search-related ads rose by about 13 percent in the third quarter. Google should follow suit, they say, both in the United States and on an international front.

What's uncertain to some analysts is Google's operating expenses. Visibility into how much Google is investing in research and development, as well as sales and marketing, is cloudy, they say. But Mark Mahaney, a financial analyst at American Technology Research, said he expects its operating expenses to rise 6 percent to $220 million on earnings before interest, taxes, depreciation and amortization (EBITDA). That excludes traffic acquisition costs, stock-based compensation and a charge related to a settlement with Yahoo.

"If it's materially higher or lower than that, it could have stock ramifications in Google vs. Yahoo," Mahaney said. He expects Google to report $467 million in net revenue, with 12 percent to 13 percent sequential revenue growth in paid search.

Google will buck a trend toward weaker third-quarter sales that has affected other companies, analysts expect, based on an "IPO effect" that has spurred demand. Analysts project Google's earnings to rise sequentially from between 10 percent and 13 percent. From June to September, sales for companies such as eBay and Amazon.com have tended to be flat or down as much as 5 percent on weaker demand during those months, they say.

Google also has primed its financial pump with a constant stream of new products. It recently began testing a desktop search tool, personalized search and free Web-based e-mail--all services to help endear Web searchers and broaden its advertising network. To this end, the company is rumored to be working on developing a Web browser, an instant chat service and a thin-client operating system.

"They have people working on just about any computer science project," Mahaney said. "The question is: Which are their top priorities, and how do they view each of those as viable business opportunities?"

Google has also been aggressive when it comes to acquiring new strategic partnerships. This week, it secured a deal to deliver search-related ads to America Online Europe, shutting out former AOL partner Overture for the business. Analysts said that deal should offset Google's recent loss of an advertising deal with Yahoo Japan, which Overture took over on June 1.

So-called traffic acquisition costs are estimated to eat away 80 percent of revenue for Google and Yahoo, analysts say. That means that Google and Yahoo agree to grant as much as 80 percent of the fees from search ads to partners such as AOL and Microsoft's MSN. But Susquehanna Financial's Wolk said she expects that Google agreed to pay as much as 85 percent to secure the AOL Europe deal.

For this reason, Janco's Pyykonen especially wants to see Google diversify from its dependence on search-related advertising, which accounts for 98 percent of its revenue. Other financial analysts are looking for gains in areas of local advertising and international growth individually for Google.

"Search has been one of the strongest vehicles for online advertising, and Google has been a leader," Wolk said. "The pace of growth will depend on how quickly Google, Yahoo and MSN develop new markets such as local, international and behavioral" advertising.