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Google Proves It's Mortal

By Ben Elgin After 11 blistering months as a public company, during which its stock climbed 269%, to $313 per share, Google (GOOG) finally failed to live up to investors' sky-high expectations. The search leader on July 21 unveiled second-quarter net profits of $343 million -- a 334% jump over last year's quarter, but slightly below analyst estimates. Investors trimmed Google's shares by 5%, to $299, in after-hours trading.

Google's numbers cap a disappointing week for Internet search players. Yahoo! (YHOO) on July 19 undershot second-quarter sales estimates (see BW Online, 7/20/05, "A Big Boo For Yahoo"), causing its shares to fall by 13% over the next two days.

Google had blown past profit estimates by an average of 28% in its first three quarters as a public company, making its second-quarter shortfall all the more surprising. Jefferies & Co. analyst Youssef Squali, for instance, had expected Google to beat profit estimates by 5% to 10%.

RUNAWAY ENGINE. Nevertheless, it's a small blemish on Google's otherwise torrid run. The company's second-quarter net sales jumped 110%, to $890 million, as it continues to gain market share in search over competitors Yahoo and Microsoft's (MSFT) MSN.

In addition, its search ads continue to outperform those of its rivals. According to comScore Media Metrix, the click-through rate on Google's search ads is 18%, vs. 11% for Yahoo and 12% for MSN. "It's inertia on the part of people searching," says Chris Sherman, editor of industry newsletter SearchDay. "Old habits are hard to break."

Google's soaring performance in the face of its competitors' best efforts has strengthened the stomachs of its investors. Before its second-quarter announcement, Google's market valuation had soared to $87 billion, making it easily the richest Internet company. Its market cap also surpasses industry stalwarts such as Boeing (BA), McDonald's (MCD), and Ford (F). Much of Google's stock gains came in the last quarter, as its shares climbed 54%.

TALENT MAGNET. Sticking with its practice, Google declined to offer financial guidance for upcoming quarters. But company executives strongly urged caution during its conference call with analysts. Google Chief Financial Officer George Reyes described the second and third quarters as traditionally weak in terms of Internet use and search volume. Moreover, he said last year's third-quarter metrics may have been abnormally high due to the huge amount of publicity surrounding Google's IPO.

One of Google's brightest spots for the quarter was its ability to hire and attract talent. In recent weeks, the company announced it has hired Louis Monier, former research director at eBay (EBAY), as well as Kai-Fu Lee, a longtime top scientist and vice-president at Microsoft. The software giant has since filed a suit against both Google and Lee (see BW Online, 7/20/05, "Microsoft Sues over Google Hire").

For the quarter, Google's net headcount grew by about 700 employees, viewed as an achievement by company execs who have said hiring talent is one of Google's biggest constraints. "Great engineering is the foundation upon which we built Google," CFO Reyes told analysts on the conference call.

Still, Google's second-quarter results carry a weighty note of caution. After an incredible run, Wall Street expectations may have finally matched, if not exceeded, what the search kingpin can deliver. Elgin is a correspondent in BusinessWeek's Silicon Valley bureau

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