Google's Giant Stride

Its latest earnings report is a blockbuster -- and a confirmation that doubts about the outfit's growth potential were premature

Google had a lot to prove to investors when it reported first-quarter earnings Apr. 20. After reaching an all-time high of $471.63 on Jan. 11, its shares had tumbled 12%, in part because Google (GOOG) missed analysts' lofty estimates for the fourth quarter.

In addition, the company sent a series of mixed signals about its prospects in the following weeks. On Feb. 28, Chief Financial Officer George Reyes told analysts that "clearly our growth rates are slowing." Then, a few days later, it inadvertently released a slide from an investor presentation that gave strong financial guidance and said the ads business was "healthy and growing and...on a strong trajectory."

On Apr. 20, Google dispelled all the confusion. After the market closed, it delivered blockbuster earnings that left no doubt the company is still going strong. Google's revenues for the quarter soared 79%, to $2.25 billion, over the year-earlier quarter, while earnings surged 60%, to $592.3 million. Excluding fees paid to its advertising partners, revenues were $1.53 billion. Earnings per share came in at $2.29, beating the average analyst estimate by 25 cents.

Google shares skyrocketed in after-market trading, soaring $25 in less than a minute. It was trading at about $447, up from its close at $415. "It reaffirms the expectation that Google continues to gain marke tshare against Yahoo! (YHOO) across the board," says Martin Pyykkonen, analyst at investment bank Hofer & Arnett.


  It's not just Yahoo. Google is widening its lead in the search market, despite more aggressive competition from Microsoft (MSFT) and many others, according to an April study from researcher eMarketer. Google is expected to grab 57% of the $15.6 billion spent on paid search advertising in the U.S. in 2006, according to the study. Yahoo, the next biggest competitor, is expected to nab just 27%. Google's share of the market in 2005 was 48.5%. "Our own internal estimates show that we are gaining share in all areas, [including] the U.S., the U.K., and India," said Google Chief Executive Officer Eric Schmidt in a conference call with investors.

No need to pass the hat for Yahoo, however. The company reported its own solid earnings on Apr. 18. Revenues increased 35%, to $1.57 billion. It didn't, however, break out how much of its revenues came from search advertising.

Google's prospects for the future look bright. The online advertising party should keep grooving for at least the next few years, says Imran Khan, analyst with JPMorgan. The amount of money spent on online advertising in the U.S. is 5.4% of total advertising spending, according to eMarketer. That's far short of the percentage of time users spend surfing the Internet vs. consuming newspapers, magazines, and TV.

Traditional marketers will continue to pour a bigger percentage of their budgets into Internet advertising to narrow that gap, says Khan. JPMorgan predicts search ads will grow by 25% in 2006 alone, and branded advertising will grow by 20% year-over-year for the next four years.


 . Still, the changing nature of the online ad market will present challenges for the search giant. Youseff Squali, an analyst with Jefferies & Co., believes that the next big area of growth for online will be in brand advertising, including banner ads and video, as big companies like Nike (NKE) and Procter & Gamble (PG) incorporate more Internet ads into massive branding campaigns. The importance of search ads, relative to that growth, may fade.

That would play to the strengths of Yahoo, Microsoft, and AOL (TWX). Google, with its spare search engine, has barely any presence in brand advertising. It only places such ads on its partners Web sites, not on its own. While the market as a whole will grow, "the competitive landscape on the branded side is a lot more difficult and competitive than it has been in search," says Squali.

Even on the Apr. 20 conference call, after a gaggle of Google executives discussed its strong earnings, analysts asked about the company's ability to branch out in online advertising. "Can you fully participate in growth of branded advertising, which arguably has seen a nice acceleration?" asked Squali.

Larry Page, the company's co-founder and president, responded: "We don't have any philosophical issues as far as placing branded ads on our own site, and certainly on our network sites. We'd be happy to use [them] in the proper places. Search is not the optimal place [for branded ads] but we have many places...we'd be open to considering. Additionally, the network that we have is very, very large, and that's part of our strength as a business."

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