Google Undergoes Global Growing Pains

Beijing. Milan. Brussels. For attorneys at Google (GOOG), this is no vacation itinerary. Rather, it's part of a growing list of sites around the world where Google's widening empire is under fire.

Two unrelated incidents involving scrutiny of Google by foreign regulators on Feb. 24 reminded analysts and investors that the company's global expansion comes at a cost. "As an investor, you have to be aware of this and at some level you have to be concerned," says Heath Terry, an analyst at FBR Capital Markets (FBCM). "In the aggregate, [foreign incidents like these] show what kind of target Google is going to become and at some level will limit the plans they have."

The European Union said it is examining complaints from companies that accuse Google of demoting links to their sites in search results. The same day, a court in Italy found Google managers and a former employee of the Mountain View (Calif.)-based company responsible for privacy violations caused by a user-submitted video on YouTube. The flare-ups in Europe come just six weeks after Google threatened to shutter some Chinese operations after a cyber attack on its users was linked to the country.

International markets made up $3.5 billion, or 52% of Google's revenue, in the three months ended Dec. 31. In the days following Google's standoff with the Chinese government in January, some analysts said the company could afford to give up its business in that country, since it represented a tiny fraction, or less than 4%, of sales. Google doesn't disclose all European sales, though it says the U.K. alone makes up 12% of the total.

Overseas Markets' Importance

Building business outside the U.S. is paramount as growth slows in domestic search advertising, Google's strongest business. "People's expectations for how Google will be able to grow over the long term are based on geographic and product expansion," says Michael Pytosh, tech analyst for ING Investment Management, which oversees $600 billion. The fund formerly held shares in Google but sold them in part amid concerns it had become too reliant on U.S. search, Pytosh says.

The complaints lodged with the European Commission by U.K. shopping site Foundem, French legal search engine, and a Microsoft (MSFT)-owned price comparison service accuse Google of using its dominant position in the search market to stifle competition. Google controls almost 80% of the Web search market in Europe, a higher proportion than in the U.S. The company says it complies with competition laws in the countries where it operates. "The question [the complaints] ultimately pose is whether Google is doing anything to choke off competition or hurt our users and partners," Julia Holtz, Google senior competition counsel, wrote in a blog post. "This is not the case."

The European Commission is conducting a preliminary review of the complaints, and has not announced a formal antitrust investigation. But it presents a new risk, analysts say. "If some sort of antitrust action is taken, it could hurt Google's business model," says Jim Friedland, analyst at Cowen & Co. (COWN). Though it's unlikely, one worst-case scenario would be the EU forcing Google to reveal why it ranks some search results higher compared with others.

Google already faces antitrust allegations in Germany. There, two publishers associations complain that Google doesn't pay for parts of news items it displays on its Google News site, while Euro-Cities AG, a map service provider, says Google wrongly displays Google maps for free, preventing competition. Microsoft also has accused Google of anticompetitive behavior in Germany.

European Regulators "a Different Breed"

In France, a report commissioned by the Culture Ministry said Google and other companies should be subject to a tax on Internet advertising revenue, Bloomberg News reported in January. In December, a Paris court asked Google to stop scanning French works for its digital library project in the country, a venture that French President Nicolas Sarkozy said could "deprive" France of its "heritage."

A history of scrutiny of U.S. businesses including Intel (INTC) and Microsoft by European regulators is already provoking concern among some Google investors. "Google's situation is probably less at risk, but the regulators in Europe are a different breed," says Rob Lutts, chief investment officer of Cabot Money Management, which manages about $500 million, including Google shares. "If the regulators want to knock [Google] down a bit and make it so the local companies could compete, they could do it."

Just as concerns rise in Europe, tensions in China may be on the decline. In February, the company advertised for dozens of new jobs in the country, introduced new services, and lured back skittish advertisers. Analysts are taking these indicators as signs that the company has begun to repair relations with Chinese authorities in private negotiations, and may be poised to announce a compromise regarding censored search. That could bode well for Google's stock, which has sunk 10% since Jan. 12, when the company announced plans to stop censoring search results. On Feb. 24, Google stock slipped 0.7% to $531.47.

And unlike companies that might find many legal challenges distracting, Google is well-equipped to handle a multi-front war, says Youssef Squali, a financial analyst at Jefferies & Co. (JEF), who expects European business to contribute about 50% to 55% of Google's revenue over the next two years. "From the get-go, Google has had everybody gunning for them," Squali says. "They've managed to grow the business while navigating under these legal issues."

Even so, Google's lawyers will need to keep their passports close at hand.

Before it's here, it's on the Bloomberg Terminal.