The search powerhouse's second-quarter earnings increased 19%, but investors got spooked by a drop in revenue per click
The online ad market will remain in the doldrums, investors concluded after Google (GOOG) reported second-quarter earnings.
Results released July 16 showed a big drop in so-called revenue per click, a measure of the value placed by marketers on ads shown by Google, and more generally a barometer of the health of online advertising. The average amount paid by advertisers when a Web user clicks on an ad placed by Google dropped 13% in the period that ended June 30. The decline in revenue per click overshadowed other results, including sales that bested Wall Street's expectations by a hair and better-than-expected earnings that showed Google is keeping costs under control.
Shares of Google fell 3.4% in extended trading after closing July 16 up 4.43, or 1%, at 442.60. "The downturn is finally getting to Google," says Jeffrey Lindsay, a senior analyst at Sanford C. Bernstein who has an outperform rating on Google's stock. The drop in revenue per click shows that Web users are clicking on ads to comparison-shop without buying products, and buying lower-cost items online compared with a year ago, Lindsay says. Those behaviors mean ads are less valuable to marketers, and result in lower payments to Google.
Beating Wall Street Expectations
Now, investors will be watching the results of other Internet companies to see whether the online ad market can pull out of the slump that's left search marketing spending 20% lower in each of the first two quarters of 2009. Analysts fret Google's results portend weakness in pictorial and video display ads, which tend to be less effective and therefore less valuable than ads placed alongside search results. Falling demand for display ads bodes ill for Yahoo (YHOO), scheduled to report second-quarter earnings on July 21. "If paid search catches a cold, then display will probably get pneumonia," Bernstein's Lindsay says.
Revenue at Google slightly beat Wall Street analysts' expectations, increasing 3%, to $5.52 billion. After subtracting payments Google made to other Web sites that host its ads, revenue was $4.07 billion, vs. analysts' consensus estimate of $4.06 billion. Net income was $1.48 billion, up 19% from $1.25 billion a year ago. Google earned $4.66 per share, or $5.36 after removing the cost of stock compensation for employees. Wall Street had expected earnings of $5.09.
Chief Executive Eric Schmidt said on a conference call with analysts that the results show that "Google's business appears to have stabilized.…A quarter ago, we had no idea where the bottom was." He credited "careful cost controls" with helping profitability—Google's workforce declined by 375 employees by the end of the second quarter compared with three months earlier. That was the third consecutive quarterly decline in Google's staff size.
Questions About YouTube
Stability aside, Schmidt added that "it's too early for us to tell when the recovery will materialize." He added that the company is "very well-positioned for the future." Indeed, analysts say the company's emphasis on selling ads through an automated bidding system—rather than, say, lengthy negotiations with advertisers—will help Google benefit quickly from an eventual comeback.
Google's stock has been on a roll of late. The shares have risen nearly 14% since Google's first-quarter earnings report on Apr. 16, as investors credited Google with boosting profit margins even as the recession sapped demand for the online advertising that makes up most of Google's sales.
New questions are weighing on investors' minds now. They're looking for more clarity about how Google plans to make money from its YouTube site, and whether investments in display ads are paying off. "It seems like they've been working on those for some time, and not much has come of them," says Scott Kessler, an equity analyst at Standard & Poor's, which like BusinessWeek is owned by The McGraw-Hill Companies (MHP). Analysts are also watching whether Microsoft's (MSFT) new vigor on the Web will take a bite out of Google's search-engine market share and sales of its online business applications.
Bing Making Inroads
Google's growth has slowed precipitously as advertisers cut back on spending amid the recession. Wall Street expects Google's revenue to rise just 4.4% this year, compared with 31.3% in 2008. Google is trying to generate more revenue from YouTube by including more professionally produced videos with ad clips that play before the videos start, the company told analysts.
Schmidt also pointed to recently signed corporate customers of Google Apps, its productivity software that has struggled to attract large companies as customers. "The model is beginning to work," Schmidt said. Microsoft on July 13 announced its Office 2010 productivity software, which will include free Web versions of Word and other applications that will compete with Google Apps.
Microsoft and Google are squaring off on several fronts. Microsoft's Bing search engine, which debuted in May, has been gaining favor among users. A July 16 report from market researcher ComScore (SCOR) showed Microsoft gained nearly a half-point of U.S. search market share in June, when Bing accounted for 8.4% of searches. While Google still commands the vast majority of Web searches, with a 65% U.S. share, June marked the first time it didn't gain share since January.
Chrome OS Likely to Be Free
Google isn't sitting idly by as Microsoft treads on its turf. The company said on July 8 that it's developing an operating system, called Chrome OS, to challenge Microsoft's Windows. Schmidt said Google probably won't charge for the software, but hopes its use leads to more time spent on Google's sites. "You don't change the world incrementally," Schmidt said. "You do it through big innovation," like a new PC operating system, he said.
Wall Street is waiting for Google's innovation to trickle down to the bottom line. While it does, the search giant is trying to shake off the effects of an advertising slide that doesn't show signs of abating.