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Date7/23/07 Google (GOOG): Earnings

Current Price $512.51


update, maintain BUY rating
52WK HI $558.58 • Industry: Internet Services
52WK LO $392.74 • GOOG: NASDAQ; $512.51
EPS (TTM) $11.53 • 12-month price target: $560.00
Shares Outstanding 315M Buy initiated 6/26/06: $404.22 Buy 7/21/06: $387.12
Market Cap. $159B Target: $500.00 Target: $500.00
Dividend Yield NA
Price/Earnings (TTM) 44X
Price/Sales (TTM) 13.5X
EV/Revenue (TTM) 12.5X
EV/EBITDA (TTM) 28X
EBITDA (TTM) $5.2B
Buy 2/01/07 Target: $560

Brian Bolan
Director of Research Company Description
Technology Google is an internet search and technology company that has
established itself as the leader in its growing market. Free downloads of
Jackson Securities, LLC
300 S. Wacker Dr., Suite 2450
applications, tools and other products have helped to fortify the brand
Chicago, IL 60606 which has come to stand for something more than just a search engine.
Ph: (312) 253-0578 Valuation and Recommendation:
Fax: (312) 986-0560
As a leader in a growing market, we see many opportunities for Google to
Skype: BBolan grow revenue, earnings and market share. We continue to recommend
bbolan@jacksonsecurities.com investors BUY shares of Google.

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Google (GOOG)

Summary

All good things must come to an end, even the good thing that has
been Google beating the street estimate. Google disappointed Wall
Street with earnings that fell below expectations for the first time,
as revenue growth slowed and expenses grew. The combination
of slowing sales and growing expenses is bad no matter what
business you are in.

Earnings

After the close, Google reported earnings of $3.56 per share well
below our aggressive earnings estimate of $3.93 and below the
consensus estimate of $3.59. Net revenues of $2.722B were above
our $2.677B estimate. We should note that our estimate was
among the most aggressive on Wall Street.

Google Sites Vs Network sites

The quarter can be summed up quite easily when you look at the
break out of the top line. Google Web Sites brought in $2.486B in
sales, an increase of 9% from the previous quarter and 74% from
the year ago quarter. Network sites, however, did not perform
quite as well. $1.352B in sales was 7% lower than our estimate
and essentially flat with the previous quarter. Growth of 36% from
the same period a year a go is good, but will not help when the
stock tries to support its lofty multiple.

We further note that licensing revenues experienced a sequential


decrease. While this line item is only 1% of total revenues, the
sequential decline in revenues is something that is almost
completely shocking to us. At this stage of its life, Google should
still be exhibiting growth in every category. The flat performance
of the Network Sites and the decrease in revenue from the
Licensing business is troubling to us.

Bullet points from the conference call

∗ Summer seasonality appears to be milder than expected.

Brian Bolan 2
Director of Equity Research – Technology Research
Google (GOOG)

∗ Revenue per query and CTR’s are strong.


∗ Headcount will be watched very closely.
∗ Traffic growth globally contributed to the growth in GOOG
sites.
∗ Seasonality for AdSense and changes to certain partners
affected revenue.
∗ Adsense for content was affected by changes in policy.

Market Share

Third party numbers continue to suggest that Google is dominating


the competition in terms of search market share. We expect this
trend to continue, but following the most recent quarter we believe
investors should take this idea with a grain of salt. At the present
time, we still see some space for Google to gain share, but we see
even more opportunities for to loose share to the smaller players.
We bring this idea to the forefront following the earnings call with
eBay, in which eBay noted that they saw very good ROI’s when
they shifted their advertising budget away from Google to other
players for a period of 10 days. Ask.com, MSN and AOL all
provided very good returns for eBay, as did Yahoo!.

eBay is a significant customer, but due to the huge number of


clients and ultimately the large amount of revenue, its unlikely that
the loss of eBay would cause us to lower estimates dramatically.
We do believe that eBay and other larger scale buyers will
continue to look for the best opportunities to increase their own
businesses and that may come from sources other than Google.

Taxes…. 25.5% vs our estimate of 26%

It seems that every quarter we are writing about how the tax rate
boosted earnings. It appears as though this consistent gaffe has
been figured out. Our tax rate estimate of 26% compared quite
favorably with the actual rate of 25.5%. We currently estimate that
the company will post tax rates of 26% for the third and forth
quarters of 2007, but we are wary that a tax adjustment to “true up”
numbers may be coming in the third or fourth quarter. We recall
that guidance had been for a tax rate of 30% for the year, and a
25.9% rate in 1Q07 and 25.5% rate in 2Q07 leaves us two quarters
to see a rate well in excess of 30% if guidance is to be believed.

Brian Bolan 3
Director of Equity Research – Technology Research
Google (GOOG)

Key Takeaway:

This quarter was really a stunner, with the key takeaway being the
flat growth of Network Sites. Even as TAC continues to rise we
believe that large publishers are looking for alternatives to Google.
With search as its core and responsible for a majority of the
revenue, we see TAC increasing in the coming quarters and a
continued stagnation of Network revenues.

Looking ahead

We know the worst is behind us, but we believe that there is still
some trouble yet to come. The third quarter does get a late boost
from the academic community which tends to use Google more
than Yahoo!. However, we also believe that Network revenues
will not move much from their present position and only a minimal
growth has been modeled into our estimates.

TAC

TAC or traffic acquisition cost, continues to rise. This quarter saw


another increase to 85.1% of Network revenues. This implies that
the revenue sharing deals with larger publishers are beginning to
meaningfully increase. The TAC number in our model has been
increased yet again, to 85.8% in the third quarter and 88% in the
fourth quarter of this year..

In the prior quarter we noted that the largest of advertisers may


look to switch providers if their needs are not met, and we believe
we saw this evidenced in the flat Network Revneues line. With
TAC likely to continue to increase, we see little reason to expect a
great number of large advertisers to commit more content to
Google.

Error in our Model

While going through our model for 2Q07 we noticed an error that
caused our estimated to be inflated by about $62.5M on the bottom
line. This was due to the treatment of stock options and the related

Brian Bolan 4
Director of Equity Research – Technology Research
Google (GOOG)

tax affect. This would have changed our lofty estimate of $3.93 to
$3.73. We have corrected the error for future quarters.
Valuation

Our target of $560 per share and buy rating suggest that we are
bullish on the stock. Our target price is derived from a multiple of
36x this years earnings estimate of $15.28. Our view on the
valuation is that Google is priced at a discount compared to its
peers. We recommend investors buy shares of Google.

2Q07 Earnings Analysis for Google source: Company reports and Jackson Securities.

Brian Bolan 5
Director of Equity Research – Technology Research
Disclosures:

Analyst Certification
I, Brian Bolan, hereby certify that the views expressed in this research report accurately reflect my personal
views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will
be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I
may be compensated in part based on the overall profitability of Jackson Securities, LLC, which includes
earnings from investment banking and all other aspects of the firm’s business.

Conflicts of interest:
Neither Jackson Securities nor any of its publishing analysts or their immediate family members has a position
in the securities described herein.

Compensation:
The research analyst has not received compensation based upon investment banking revenues or from the
subject company in the last 12 months.
Jackson Securities has not in the last 12 months managed or co-managed a public offering of securities,
received compensation for investment banking services from the subject company or any compensation for
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Jackson Securities will seek investment banking compensation from the subject company in the next 3 months.

Position as Officer or Director:


Neither the research analysts nor members of their immediate households occupy positions as an officer or
director with the company/companies mentioned in this report.

Market Making:
Jackson Securities does not make a market in this stock

Explanation of Ratings:
Buy - Expected 12-month absolute performance of +10% or higher than the market price at which time the
rating was issued.
Hold - Expected 12-month absolute performance of +5% to –5% from the price at the time the rating was
issued.
Sell - Expected 12-month absolute performance of –10% or lower than the market price at which time the
rating was issued.

Distribution of Ratings:
Jackson Securities, LLC has a distribution of ratings among its coverage universe as follows:

Buys – 52.8% (19 of 36 active recommendations)


Holds – 38.9% (14 of 36 active recommendations)
Sells – 8.3% (3 of 36 active recommendations)

Jackson Securities has provided investment banking services within the previous 12 months with the
following percentage of the companies they have rated:

Brian Bolan
Research Analyst – Technology
Buys – 0% (0 of 36 active recommendations)
Holds – 0% (0 of 36 active recommendations)
Sells – 0% (0 of 36 active recommendations)

Risks: General economic conditions, economic slowdown/recession, adverse industry news.

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Brian Bolan
Research Analyst – Technology