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January 30, 2006
Why Is DSO Rising at Google and Yahoo?
So tomorrow (Tue. 1/31) is Google's big fourth-quarter earnings day, and everybody's waiting with bated breath to see whether the search company's earnings per share come in better than Yahoo's recent "disappointing" (to the Street) results. Personally, I don't care much about EPS at these companies. But I will be watching Google's DSO--that's days sales outstanding, a measure of how long it takes a company to collect the cash it's owed from customers. While the world has been obsessing over earnings at Google and Yahoo, DSO at both companies has quietly risen 20% and 13%, respectively, over the past six quarters. During the same period, average accounts receivable turnover--the number of times a company collects its receivables relative to sales--has dropped 16% and 12%, respectively. These numbers shouldn't set off major alarms, but they shouldn't be ignored either. They mean that Google and Yahoo have actually banked less and less of the revenue that they report each quarter.
Why should we care? As long as Google keeps delivering gargantuan earnings growth, so what if it takes a little longer to collect payments? Isn't that to be expected from a company that's growing so fast? Indeed, Google's management addressed rising DSO for the first time on the company's last quarterly conference call: "This increase reflects the growth of our international business, where credit terms tend to be longer, as well as extended credit to certain customers in the United States," said CFO George Reyes.
Like management, every sell-side analyst I've asked about this issue has mentioned the international business. "A lot of these [non-U.S.] advertisers are testing the paid search model, and they request longer payment terms than they do in the U.S.," says Imran Khan, an analyst at JPMorgan, who estimates that 14% of Google's advertising came from the U.K. last quarter. German and French advertisers have been giving Google more and more business, too. Far be it from me to doubt this explanation. But I just can't wrap my mind around why it takes Europeans longer to pay their bills than Americans. Aren't some U.S. advertisers experimenting with paid search for the first time, too?
Apparently yes, and they tend to be large companies that are used to getting extended credit terms from traditional media companies (think Procter & Gamble putting the screws to CBS, or some such). At least that's the explanation from analysts and Google's management. Sounds credible enough. But I'll throw out another theory, as yet untested.
The search advertising market is getting awfully competitive, what with Microsoft, Time Warner, News Corp., and everyone else vying against Google and Yahoo. Seems to me that big advertisers should be able to play these companies off each other and demand all kinds of special treatment. The first law of finance is that a dollar in hand today is worth more than a dollar in hand tomorrow. In business, power relationships are often defined by who's slowest to pay and who's fastest to collect. As Google and Yahoo start doing business with more powerful advertisers, it makes sense that collection times will lengthen.
The question is how much. JPMorgan's Khan says he wouldn't worry unless quarterly DSO rose above 70 days (last quarter, it was 31 days at Google and 43 days at Yahoo) or jumped 15% or more in one quarter. But if everyone's myopically focused on EPS, DSO could inch up every quarter indefinitely. In addition to EPS growth, one factor by which management teams should be judged is how many days they can keep cash inside the company, where it can earn interest, fund expansion plans, or even pay dividends (what a concept!). EPS growth is like sex appeal--it works wonders when you're young, but you can't rely on it as you age. Disciplined cash-flow management, on the other hand, is like a good education--if you get it while you're young, it keeps paying off throughout life.
UPDATE 2/1/06: Google reported yesterday that DSO ticked up two more days during the fourth quarter of 2005. Management recited the same boilerplate explation verbatim as last quarter.... On an unrelated note, can anyone explain what benefit Google gets from estimating its tax expense annually rather than quarterly? And why did the company not see earlier that the year-end "true up" of its tax provision would have a diproportionate impact on the fourth quarter? Comments, please.
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