Analzying The Analysts And Why Google Will Deliver Upside To Analysts' Estimates

Another Wall Street analyst essentially admits that he does not have a clue how Google’s quarter will perform. This time it’s Spencer Wang from Credit Suisse. I cannot blame him because no one has developed an edge on this stock since it went public in August 2004, which is why it is a cult stock and should remain that way for years to come. However, if the buyside is paying the sellside millions in commissions then the sellside needs to come up with something intelligible to say.

Wang’s angle is that data from third parties like CPCs, number of searches, coverage, and click-thrus, the underpinnings of Google’s revenue DNA, has largely been unreliable in predicting Google’s revenues. Instead, we should focus on the comments from the companies that do business with Google, such as the SEMs, who have real data on Google’s performance.

Never mind that these firms have limited data and that their data is typically skewed towards one or two advertising verticals or that their data is limited geographically. Several firms have often provided inconsistent and sometimes conflicting numbers in the past. And yes, they have been wrong. So I wouldn't base my analysis solely on comments from these firms.

He goes on to diss comScore's numbers as uncorrelated with Google's actual reported figures. In comScore's defense, there were a number of occasions where their U.S. numbers were dead on with what I calculated. Netratings also has good numbers and they are free.

The best way to analyze Google's quarter is to take a combination of the analytical numbers from the third parties and the qualitative comments and then draw your conclusions. I have been able to mathematically analyze the comScore data I received from friends in the past and came close to the reported figure for Google, so look for this analysis in the future.

He then goes on to say that he cannot trust third parties that track cost-per-click trends. CPC growth on Google dropped to 8% YoY in 3Q08, from 14% YoY in 2Q08, and 17% YoY in 1Q08. Sequentially, CPC Growth was -1% in 3Q08, 3% in 2Q08, and 3% in 1Q08. Wang estimates that CPC growth will be up 1.7% sequentially. My work has the figure coming in closer to 5% sequentially.

On paid clicks, he thinks the number will be flattish sequentially (.6%), which is consistent with his contacts (I assume he means the SEMs not Google employees). His number implies an 8% YoY growth rate, down from 18% in the 3Q08. That would be bad, but I assume that has already been reflected in the stock price given that most analysts are calling for flattish seq growth in paid clicks. I think the true number comes in at 12% YoY implying 3% sequential growth in paid clicks. I am still doing work on this so look for an update in the future.

Taken together, my 5% seq growth rate in CPC and 3% seq growth rate in paid clicks would cause the stock to rally, depending on what happens with costs this quarter and comments from management on the call. More on costs in a subsequent post but with management's recent efforts on cost containment, EBITDA margins are likely to improve in 4Q. Surprisingly, Wang did not tackle costs in his report!

Overall, he leaves his 4Q08 numbers unchanged (all that and he leaves his numbers unchanged) but took his 2009 numbers down. He reduced his paid click growth to 7% from 14% but left his CPC growth estimate unchanged at 5%.

I think Google will surprise on the upside when they report results in January and I plan to buy more shares if there is a pull back. I got in aggressively at $250-$275. I also sold Jan 09 puts. At current prices the stock has priced in a worse case scenario of an earning miss or flat growth in paid clicks, and given that so many analysts have taken down their numbers, that risk has diminished. So I think downside for Google is limited here.

Consensus has Google reporting $4.217bn in net revenues (4% seq growth), 58.5% Adj. EBITDA margin, and $5.00 in Adj. EPS. Wang focuses on gross revenues so I do not have comparable numbers to report here, except for Adj. EPS, which he has at $4.94 (he doesn't have a TAC number, the second most important number in the financials, in his report).

So the bar is being set low for Google this quarter and is likely to come down further as analysts come out with previews. This gives me more confidence of an earnings beat in January. One caveat is that the U.K. is typically weak in the 4Qs due to the travel vertical, which softens in that quarter so some reason. I admit that there will be pressure on the stock or negative press if the paid click YoY growth rate is in the single digits, but I am willing to bet that this is unlikely.

As a Side, Google's CEO was on Meet The Press. I am still holding on to my thinking that he steps down in 2009 - See prior post. Either that or Google's quarter is performing well, affording him the time to appear on television programs. Imagine the time he needs to put in to prepare for these television interviews. He noted that he is seeing increased searches for the words bargains and discounts, but more importantly, people are buying. The latter being a positive read-thru for Amazon.

FYI - I am currently focusing on the Internet stocks for now because of the volatility and opportunity for quicker profits. I am also focusing on Apple, RIMM, Microsoft and EMC. The other media, tech, and telecom names are quite frankly boring to trade now. Newspapers are essentially dead unless you can short them. The entertainment stocks are not as volatile as I would like right now. Satellite radio is an essentially dead trade now as is the cable and satellite names, although I made money shorting DISH over the past few months. Telecom isn't all that attractive either given the problems at Nokia and Sprint.

Full Disclosure: I currently have positions in Google, Amazon, Apple, and Microsoft.

-TMT