Google's earnings miss tests stock market's love affair with company

Wednesday, February 1st 2006, 8:47 am

By: News On 6

SAN FRANCISCO (AP) _ Google Inc. co-founders Larry Page and Sergey Brin have always insisted they will run their 7-year-old company the way they want, even it means ignoring stock market pressures to hit a widely watched earnings target.

Now, that defiant attitude is about to be tested, along with investors' affection for the online search engine leader, after Tuesday's release of a fourth-quarter earnings report that badly missed analyst estimates.

``This shows that Google is not impervious,'' Standard & Poor's analyst Scott Kessler said.

That realization rattled previously bullish investors as Google's stock price plunged by more than 12 percent in after-hours trading, wiping out more than $16 billion in shareholder wealth, more than the current market value of General Motors Corp. That backlash trimmed a combined $3.5 billion from the net worth of Page and Brin, who are both 32.

Google stunned almost everyone who follows its stock by failing to deliver a pleasant earnings surprise for the first quarter since its August 2004 initial public offering. The Mountain View, Calif.-based company said its net income nearly doubled from the previous year to $372.2 million during the final three months of 2005.

For most companies, that kind of stellar growth is a reason to celebrate. But investors have become accustomed to much bigger things from Google, which had topped analyst estimates by at least 14 cents per share in each of its previous five quarters as a public company.

That streak of prosperity had helped to more than quadruple Google's market value in less than 18 months.

This time around, Google fell woefully short of living up to the analysts' estimates.

If not for a charitable donation and stock compensation expenses, Google said it would have earned $1.54 per share. That fell well below the average estimate of $1.76 per share among analysts surveyed by Thomson Financial.

Google released its results after the stock market closed Tuesday. Company shares plummeted $53.65 _ 12.4 percent _ in after-hours trading after gaining $5.84 to close at $432.66 on Tuesday on the Nasdaq Stock Market.

The letdown is bound to disillusion some investors, S&P's Kessler said. ``If you ask a lot of people on Main Street why they own Google, they will tell you, 'Because it goes up every day.' Well, that's a great thesis until it goes down.''

Even with the sell-off, Google's longtime investors still will be sitting on substantial gains. The company's shares went public at $85 and were trading just slightly above $300 in late October when Google released a third-quarter report that delighted investors.

One key factor didn't change for Google in the fourth quarter: advertisers are continuing to pour more money into the company's widely used search engine as more consumers spend their free time surfing the Web.

Google's revenue for the period totaled $1.92 billion, an 86 percent increase from $1.03 billion in the prior year. After subtracting commissions paid to Google's advertising partners, the company registered fourth-quarter revenue of $1.29 billion, matching analyst expectations, according to Thomson Financial.

Even so, the company's sales growth slowed in the fourth quarter, a development that is expected to continue as Google matures. Excluding ad commissions, Google's fourth-quarter revenue rose by 23 percent from the third quarter. In 2004, Google's fourth-quarter revenue increased by 30 percent from the third quarter.

CEO Eric Schmidt told analysts during a Tuesday conference call that the fourth-quarter results topped the company's internal projections. ``We are very pleased with the performance on every level,'' he said.

Google's management has steadfastly refused to publicly project its earning potential, making it difficult for analysts to reach the calculations that investors use to appraise a company's value. Google also has promised to spend heavily to improve its long-term competitive position even if those investments diminish its short-term profits.

The company isn't about to change its philosophy, Chief Financial Officer George Reyes said in a Tuesday interview.

``This is a great business with a lot of headroom,'' he said. ``It's unfortunate that this happened, but this is about the long term. We are not going to do anything stupid.''

The company would have matched the average analyst estimate if not for a much higher tax rate during the fourth quarter, Reyes said.

Google's effective tax rate in the fourth quarter was nearly 42 percent, well above the roughly 30 percent rate during the second and third quarters. The company got stuck with the higher bill because of abnormally high international expenses that shifted income to the United States and its higher tax rate, Reyes said. Google expects its 2006 tax rate to be about 30 percent.

No matter how the fourth-quarter results are dissected, the earnings represent ``a significant miss,'' said David Garrity, director of research for Investec Inc. ``You could say there was a little bit of exuberance in this stock that needed to be taken out.''

Garrity doubts investors will fully embrace Google until management provides another financial update during an analyst meeting scheduled March 2. ``Garrity predicted the stock price will range between $350 and $400 until then.

Until recently, it seemed like Google could do no wrong as its stock price rose to a new high of $475.11 shortly after the new year. Even as the company's shares soared, most analysts continued to paint a rosy scenario by predicting the price would surpass $500 and maybe even reach $600 by year's end.

But some investors began to fret about Google's earnings momentum two weeks ago when Yahoo released a fourth-quarter profit that fell a penny below analyst estimates.

The jitters surrounding Google were exacerbated after the company vowed to fight a Bush administration subpoena demanding one week's worth of search requests as the federal government seeks to revive a law designed to shield children from online pornography.

Google then provoked more angst last week by launching a new search engine in China that will censor some results to comply with the country's free-speech restrictions.