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Google Tries to Make Nice

Back in January, securities firm Piper Jaffray lifted its target on Google (GOOG) to a lofty $600 a share. At that price, seven-year-old Google would be the world's 10th-richest company by market value. It was beginning to look like another go-go year for the Internet darling, which almost doubled revenue in 2005.

Not so fast. Two months later and the company has weathered criticism for cooperating with the Chinese government in censoring the Web, and missed analysts' fourth-quarter earnings expectations. Then on Feb. 28 came unsettling comments from Google Finance Chief George Reyes.

"Clearly our growth rates are slowing, and you see that each and every quarter, and we're going to have to find other ways to monetize the business," Reyes said at an investor conference. The remarks were taken as an acknowledgment of the long-held view that Google is too reliant on a single revenue source: search-related ads.

In the wake, the stock tumbled as much as 13%. It recovered some, finishing the day down 7%, at $362.62. But it's still far below the $475.11 pinnacle reached on Jan. 11.

OUT OF CONTEXT? The volatility is subjecting Google to a painful lesson that as a public company its most valuable constituency may be its investors. Google -- which won't issue financial targets -- may have no choice but to eschew its egalitarian roots and solicit Wall Street's help to manage expectations. "This is a $100 billion publicly traded company with tens of thousands of shareholders," says Scott Kessler, an equity analyst at Standard & Poor's. "Clearly you have a lot of shareholders that have so far taken a backseat to people who casually happen upon the Web site."

For investors, it's a reminder of the perils of investing in a company that refuses to say when analyst projections are off the mark. Consider the fourth-quarter miss. Google broke a string of outperforming quarters dating back to the company's August, 2004, IPO (see BW Online, 2/01/06, "Google: Just Not Good Enough"). The bulk of the shortfall was due to an unforeseen one-time tax liability -- something that could easily have been accounted for with an earnings warning. Instead, many analysts and investors felt blindsided.

Ditto for Reyes's comments. Several analysts issued reports afterwards saying the remarks were taken out of context and not as bearish as they sounded. But for a company that won't say much to Wall Street, how much context can there be? "The law of large numbers was already baked into most estimates out there, including mine," says Martin Pyykkonen of Hoefer & Arnett. "You have to wonder, is he signaling anything beyond that? Is the first quarter going to be softer than people are expecting, and are they trying to manage those expectations?"

CHANGING ITS WAYS. Scott Devitt of Stifel Nicolaus, who recommends investors sell Google shares, is more blunt. "Why shouldn't it sell off?," he asks. "A company that is a public company should either give the owners of the company information or live in a world in which it has a discount."

That's not a new idea, just a dusty one, given the search outfit's torrid growth. Just before the 2004 initial share sale, several analysts surmised Google should trade at a discount due to the uncertainty. Many on the Street were feeling stung by what they saw as arrogance by a company that made clear in regulatory filings that it wouldn't behave like any ordinary corporation. And many were leery of Google's then-heady IPO range of $108 to $135 per share. The price got bumped down to $85 and has soared since.

There are signs that Google is already changing its ways. It recently hired its first investor-relations manager -- a standard position for most large public companies of Google's size, and a welcome addition for analysts who often didn't even know where to direct questions. For a planned Mar. 2 analyst day, Google hired a firm to call around and poll analysts on what they'd like to hear.

"SIGNS OF TROUBLE." Pyykkonen says he knows of few companies that do that. He and others are hoping the outreach means they'll get more insight into Google's businesses at future meetings and less of the fare -- such as a speech by the corporate chef -- that marked last year's analyst day.

In the survey, Kessler suggested that the company allow analysts to ask more than one question apiece on earnings conference calls. If he gets his wish, expect increasingly tough ones. For his part, Bill Fleckenstein, president of Seattle-based Fleckenstein Capital, sold his stake in Google stock this month.

Fleckenstein is now considering selling the stock short, or betting on its continued decline. "A stock price [can take] a life of its own completely independent of the business. I think that's what's happened here," he says. "If you would poll every shareholder, you would find that a large majority of people owned Google because they liked using Google, and the stock price went up. They had no clue of what owning a share of Google said about the future...there are signs of trouble."

SHARING THE PIE. Trouble indeed: The online advertising market grew from practically nothing a few years ago to $10 billion last year. Growth could start slowing to between 20% and 60% this year, analysts say. That point was hit home to Stifel Nicolaus' Devitt in January, when Yahoo! (YHOO) missed expectations, reflecting a loss of market share to Google.

"The way I look at it, this is no longer a market where everyone is growing," he says (see BW Online, 1/4/06, "Google: $600 Or Bust?"). "It's now a market-share game, and that gives you some idea of how big the market actually is."

Sure, it's good that Google grabbed share. But it already has 64% of the pie. With well funded competition in Microsoft (MSFT) and Yahoo, there's only so much higher that figure can go.

"THE MADNESS OF CROWDS." Meanwhile, companies from eBay (EBAY) to IAC/InterActiveCorp (IACI) have been complaining about continual price hikes for keywords that are the centerpiece of Google's search-related advertising system. And that paid-search advertising is 99% of Google's revenue. Even Yahoo has a mix of search and so-called branded advertising, which includes videos and banner ads.

Can becoming more Street-friendly reverse the slide in Google shares? Fleckenstein says no. "If the stock has seen its glory days, Wall Street may not be able to put Humpty Dumpty back together again," says Fleckenstein, who compares hype about Google to the fervor that once surrounded the ill-fated Netscape. "It's more about the madness of crowds."

If there is a malady leaving Google's stock price out of whack, a bit more guidance from the company could go a long way toward curing it.

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