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Google Declines as Research, Marketing Crimp Profit

Google Inc. dropped the most in three months in Nasdaq trading after reporting second-quarter profit yesterday that missed estimates, weighed down by a surge in spending.

Google, grappling with slowing growth for its traditional search-based ads, has boosted spending on acquisitions and staff to tackle new markets, including mobile marketing and display advertising. The company’s expenses climbed 22 percent to $4.46 billion in the period, a steeper gain than the 18 percent rise in the first quarter. The trend marks a shift from Google’s belt-tightening regimen during the recession, said Andy Miedler, a St. Louis-based analyst for Edward Jones.

“Investors want to see the revenue upside fall to the bottom line,” said Miedler, who recommends buying the shares and doesn’t own them himself. “Google’s is known for its free- spending ways, and when profitability takes a hit in the quarter, it reminds investors of the pre-recession Google.”

Net income rose 24 percent to $1.84 billion, or $5.71 a share, from $1.49 billion, or $4.66, a year earlier, the company said. Excluding some items, profit was $6.45 a share, compared with an average estimate of $6.52 in a Bloomberg survey of analysts.

Google, based in Mountain View, California, fell $34.42, or 7 percent, to $459.61 at 4 p.m. New York time in Nasdaq Stock Market trading, the biggest drop since April 16. The shares have lost 26 percent this year.

Why Not?

Google is investing in industries that could produce its next billion-dollar businesses, Chief Financial Officer Patrick Pichette said in an interview. Those projects may require more engineers to develop, he said.

“We do have controls -- we do manage the company very responsibly,” Pichette said. “The question for me is actually the opposite, which is: In this kind of environment, where we know the digital economy is really going gangbusters, why would we not invest?”

Unlike profit, Google’s sales topped analysts’ projections. Excluding revenue passed on to partner sites, sales rose to $5.09 billion last quarter. The average estimate was $4.98 billion.

Estimates for the quarter declined in the past four weeks as the dollar strengthened against other currencies, including the euro, fueling concern that overseas revenue would be worth less when brought back to the U.S. Analysts cut sales estimates by an average of $21.8 million, according to Bloomberg data.

Bonds Approved

Google also announced its first bond offering yesterday, saying its board had authorized the company to borrow as much as $3 billion to fund general corporate expenses. Moody’s Investors Service assigned Google an Aa2 rating, the third-highest investment grade.

The ranking reflects Google’s leadership in Internet search and online advertising, as well as the potential growth from YouTube, mobile advertising and operating systems, the ratings company said. Moody’s also cited Google’s $30 billion of cash and lack of debt.

It doesn’t hurt to have the option to use bonds, said Richard Lane, an analyst with Moody’s in New York.

“To the extent there’s a need for money, whether it’s a short-term purpose or a long-term purpose, having different options in terms of how to finance business activity is better than having fewer options,” he said. “The cost of debt, should they chose to raise debt, is very attractive right now.”

The company’s cash and short-term investments rose to $30.1 billion during the second quarter. Google had $26.5 billion in the first quarter, up from $24.5 billion at the end of 2009.

Using Its Cash

Google is putting its cash to work to find future sources of revenue growth. Search-based online ad spending will rise 16 percent this year, then decelerate to 8.6 percent in 2011, according to EMarketer Inc. of New York.

The company increased its staff by almost 1,200 to 21,805 people during the quarter. Google, which gained around 300 workers from acquisitions, is using many of the new hires for sales and engineering projects.

Even so, the original search business still accounts for a majority of Google’s sales and profit.

“At some point you would like to see stronger revenue growth from the non-search areas pick up,” said Aaron Kessler, an analyst with ThinkEquity LLC in San Francisco. He rates the stock a buy and doesn’t own it.

Acquisition Strategy

Acquisitions are a growing part of Google’s expansion plans. It has announced or completed more than a dozen purchases this year. The company said on a blog today that it bought San Francisco-based Metaweb Technologies, a company with databases that cover subjects from movies and books to companies.

In May, Google wrapped up its $750 million deal to buy AdMob Inc., a provider of display ads that go on mobile applications and websites, following approval by the U.S. Federal Trade Commission.

This year, AdMob and Google together may generate more than $100 million in U.S. mobile-ad sales, according to IDC in Framingham, Massachusetts.

Earlier this month, Google said it had agreed to buy flight-information provider ITA Software Inc. for $700 million. The deal gives it more of the online travel business and helps it compete with rivals Microsoft Corp. and Kayak.com.

To contact the reporter on this story: Brian Womack in San Francisco at bwomack1@bloomberg.net

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