Google’s Challenge to Facebook Seen Eroding Profit as Page Boosts Spending

Google Inc. (GOOG)’s challenge to Facebook Inc. in social networking, an effort analysts said will cost more than $200 million, probably slowed second-quarter profit growth for the world’s largest Web search engine.

Profit excluding some costs rose to $7.85 a share in the period, Google will report later today, according to analysts surveyed by Bloomberg. Profit would have been higher if not for spending on Google+, a service unveiled by new Chief Executive Officer Larry Page last month to compete with Facebook, said Colin Gillis, an analyst at BGC Partners LP.

“Larry’s here, and he’s here to spend,” said Gillis, who estimates that Google spent about $100 million on the project, half the total, in the second quarter alone. “There are some large opportunities that they’re chasing after.”

Google+, an online tool that lets users create and communicate with groups of friends, is part of Page’s attempt to lure Web users from rivals including Facebook. Higher spending on social networking, mobile software and e-commerce -- areas aimed at lessening Google’s reliance on traditional Internet search -- eats into profitability.

Adjusted operating margin, a measure of profitability that excludes certain costs, declined to less than 48 percent in the second quarter from 49.4 percent in the preceding period, said Ben Schachter, an analyst at Macquarie Capital in New York.

Photographer: Ronny Hartmann/AFP/Getty Images

Google's shares surged in after-hours trading on its second-quarter earnings report. Close

Google's shares surged in after-hours trading on its second-quarter earnings report.

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Photographer: Ronny Hartmann/AFP/Getty Images

Google's shares surged in after-hours trading on its second-quarter earnings report.

“What investors are thinking about in general right now is return on these investments,” said Schachter, who rates the stock “outperform” and doesn’t own it. “They certainly haven’t shied away from spending money. My view is that this is money that is well spent.”

Sales Boosted By Search

Second-quarter revenue, minus sales passed on to partner sites, likely rose to $6.57 billion in the June period, the average estimate of analysts. Google’s first quarter revenue of $6.54 billion, announced in April, topped analysts’ predictions.

Google, based in Mountain View, California, lost 52 cents to $537.74 at 10:02 a.m. New York time in Nasdaq Stock Market trading. The stock fell 9.4 percent this year before today.

While Google’s sales are buoyed by demand for online ads, margins are likely to keep narrowing into next year amid costs for such services as Google Offers, a feature that mirrors Groupon Inc. by providing daily deals to users at local businesses, according to Morgan Stanley.

‘Stiff Competition’

“We are encouraged by early progress of Google Plus and Google Offers, but Google faces stiff competition from incumbents who have first-mover advantage,” Morgan Stanley analysts, who downgraded the company to “equalweight” from “overweight,” wrote last week in a research note. “The payoffs of such endeavors may be longer term.”

Adding to costs, Google increased hiring by 1,900, or 7.9 percent, in the first quarter, part of its plan to boost overall hiring by 6,000 this year. Research and development costs rose 50 percent in the March period while sales and marketing increased by 69 percent.

Google is investing in social features to lure Web surfers and advertising sales from Facebook, the world’s most popular social-networking site. Online users spent an average of 6.7 hours on Facebook in June, compared with 4.1 hours on Google, according to ComScore Inc.

The release of Google+ comes after other missteps in social-related services, including Google’s Buzz and Wave. Google reached a settlement in March with the U.S. Federal Trade Commission over concerns it violated its own privacy policies with Buzz. Google stopped developing Wave, an online collaboration site, last year because of slow adoption.

‘Slicker Products’

The new service has a look and feel similar to Facebook’s, but with a focus on managing contacts around different relationships. Just days after its debut, Google temporarily shut down the invite mechanism for Google+ following “insane demand,” Vic Gundotra, head of social efforts, said on the company’s website.

“This is definitely one of the slicker products that has come out of Google in a long time,” said Sameet Sinha, an analyst at B. Riley & Co. in San Francisco who rates Google a “buy.”

Google+ is still early in its development, with less than a month for users to try out the service, Gillis said.

“It’s way too soon to make a call on Google+,” he said. “It’s a credible alternative to Facebook, but social networking is all about scale.”

The company also is boosting investment in mobile services. Google’s Android operating system is expected to maintain its lead globally this year with 38.9 percent of the worldwide smartphone market, compared with 18.2 percent for Apple Inc. (AAPL)’s iPhone, according to research firm IDC.

No ‘Repercussions’

Google, meantime, holds its lead in online searches. The company had 65.5 percent of queries in the U.S. in June, compared with No. 2 Yahoo! Inc., which had 15.9 percent, according to ComScore Inc Inc.

Overall, Google is expected to grab 41 percent of online ad revenue in the U.S. in 2011, compared with 11 percent for Yahoo, according to EMarketer Inc. in New York. Facebook should get 7 percent and Microsoft Corp. should have 6 percent.

“Having this initial success with Google+ allows them to spend without as many repercussions from investors,” Schachter said.

To contact the reporter on this story: Brian Womack in San Francisco at Bwomack1@bloomberg.net.

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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