Google: “Our Thesis is Still Intact”

“As you know, we’re in the middle of a transition in search advertising business, moving from Yahoo’s platform to our own proprietary ad platform called MSN adCenter, which we began testing in the US during the quarter.” When you hear somebody start a discussion with the qualifier “As you know,” you brace yourself for news that is not-so-great, and that’s how Microsoft began its discussion of search results at Microsoft Network on last night’s call.

The bad, though not-necessarily-unexpected, news came in the next sentence:

“The ramp-up of a new ad platform requires significant investment from Microsoft, both in development costs as well as in reduced revenues related to fewer numbers of overall advertisers and the resulting lower keyword pricing.”

In other words, Microsoft’s online search business, in the midst of the biggest boom in the history of the world, was down year-over-year and flat sequentially. Readers should keep in mind that Google is expected to show 100% year-over-year and 20-25% sequential growth when it reports earnings next week.

After a company like Microsoft, with so many hopeful investors eager for a hint of past glory, drops that kind of news, you should expect some positive spin in order to leave the masses feeling more upbeat—after all, Yahoo! got smashed last week after reporting “only” 13% sequential search growth.

Microsoft obliged as follows:

“The good news is that in response to our platform has been great, and we are ramping up deployment by rapidly on-boarding advertisers and moving more search traffic to the platform.” Microsoft may be ramping up advertisers, but that doesn’t mean it is ramping up the customers that actually use Microsoft Network. I know one individual who has shifted his entire email business away from Microsoft Network to Google’s Mail product; and based on the increasing numbers of emails I receive from “gmail.com” addresses, it appears I am not alone.

For that reason, and because of the fact that Microsoft’s entire reason for existing is not to create the greatest search product but to drive people to buy Microsoft operating system software, I doubt Microsoft will win the search war, no matter how much money it throws at the business.

Now, Google may or may not be a good investment, stock-wise. I have been a fan of the company for some time, but reasonable people can disagree on the company’s prospects and the stock’s valuation. In any case, much ink, both real and digital, will be spilled in the next few days trying to game the company’s fourth quarter earnings report, due out next Tuesday after the close.

A few weeks ago I highlighted a press release (“The Most Interesting Press Release You Didn’t See”) from FTD Group, the flower-delivery organization that utilizes internet search advertising to generating a significant portion of its business.

In the release, FTD said that online search costs had “increased significantly,” causing the company to curtail its use of the medium and ponder “a more diversified marketing portfolio.” It looked like search—for FTD, at least—had reached the limits of its marginal utility.

In response, I received a number of comments, some agreeing with the FTD experience and others disagreeing entirely. Feedback from friends whose businesses utilize search for a significant portion of their customer acquisition were likewise mixed, although more indicated that the bills they paid to Google were still increasing than not.

Just yesterday, however, another data point emerged in the search-cost conundrum, squarely on the side of Google.

1-800 Flowers.com (yes, that’s the actual name of the company) reported 21% revenue growth, as well as continued dependence on, and effectiveness of, search-based advertising:

“During the quarter we attracted more than 1.3 million new customers with 57% of them coming to us online, up from approximately 1.2 million and 54% in the second quarter of last year….

“Certainly search is an expensive yet effective marketing vehicle for us, one of our overall marketing channels. We did not see any spike in costs this holiday season. Actually, this past holiday season, search costs were comparable to last year’s holiday season.” I hesitate to extrapolate from this any firm conclusion about next Tuesday’s earnings report from Google.

However, I suspect—to use one of Wall Street’s Finests’ favorite, most clichéd, and least informative old sayings, “Our thesis is still intact.”

Jeff Matthews I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.