Friday, July 18, 2008

Google and Gas

“When everyone dislikes something it should be examined. When everyone likes something it should be examined.” -- Confucius

One of the biggest surprises to me from the Google conference call was learning that Google employs a Chief Economist. Had I only been aware of this earlier, I would’ve shorted more shares. I’ve been on many hundreds of conference calls over the years, but I’m having trouble remembering any in which a Chief Economist was one of the presenters. This was often one of the few positive qualities of these calls. Whenever I'd find myself struggling to pay attention to the mindless reading of the press release by the CEO, I'd mutter to myself, "Well, at least I don't have to listen to an economist."

The fact that high-flying, vanquish-all-comers, paradigm-changing Google is the first that I can recall offering up an economist to the investment community seems a bit ironic. This is Google! Shouldn't we be hearing from the Chief Envisioneer of World Domination instead? Perhaps this will be one of those little things we’ll point to in a few years as evidence that the days of heady growth for Google were winding down.

I wrote a critical review of Google's first quarter earnings release back in April when the stock popped from $450 to $540 and all of the analysts were tripping over themselves to see who could capture the most headlines with the biggest price target increase. In my conclusion of that piece, I said that I'd be keeping an eye on the stock and possibly buying put options if the stock kept running.

I didn't buy the put, opting to short the stock instead as increased volatility made put buying a little too expensive. And, unfortunately, I didn't short the stock as it neared $600. The short was initiated last week in the mid-$540s. Even though the stock had already pulled back 10% from its recent high, It was just too tempting. GOOG had held up better than the market during this latest downturn, and it seemed that the entirety of the sell-side community and press were bullish and expecting yet another outstanding googlerific quarter. On top of this, the concerns I shared from last quarter hadn't diminished, and the economy had deteriorated further. It was an appetizing recipe for an earnings disappointment.

Of course, the sell-side was out after the call defending their buy recommendations on Google. I haven't seen one downgrade. AmTech Research is keeping its "Buy" rating but lowering its target from $750 to $725. Cantor keeps their "Buy" and lowers their target from $750 to $675. Kaufman Bros. maintains their "Buy" and lowers their target from $680 to a nice round $657. $657? 57? 7? I mean, c'mon. You feel that confident in your $657 target that you didn't want to round it down 0.304414% to a nice even $655? How can anyone take this supposed precision seriously given the multitude of highly variable factors that go into that target in the first place? Asinine.

The average target price of these three analysts/lemmings implies 40% upside in the stock. The last downgrade I see is a beaut. Jefferies downgraded GOOG from a "Buy" to a "Hold" on February 1, 2008, the very day the company issued disappointing earnings and the stock opened 36 points lower. The downgrade also came one month AFTER the stock fell from a high of over $700 to about $520. See the station? See the train? No? That's because it's already gone. Over the following 5-6 weeks the stock traded as low as $412. When did the analyst upgrade the stock? He waited until April 18th, the day Google reported their "strong" first quarter earnings and the stock opened at $535. It would be difficult to try and time this stock worse.

So what about this quarter's earnings release? As you know by now, EPS came in a bit light, even with the benefit of currency and a nice low tax rate. Unlike the denials in the last conference call, the company finally owned up to being impacted by the slowing economy. They also admitted that the U.K. business was now large enough that seasonality was becoming evident. Paid click growth actually declined sequentially, and revenue growth (one of the concerns I highlighted last quarter) continued to slow.

Growth is clearly the overriding issue here. Huge early market share gains that could mask seasonality and economic weakness are quickly evaporating, which shouldn't be a huge surprise given the scale of GOOG. The question then turns to what the company is worth and what is an attractive stock price. With the stock now trading at about 20x 2009 estimated EPS, I don't find the stock particularly compelling, but I also no longer view it as ridiculously overvalued. Because of this, I covered the short today (Friday). I'll be watching the stock with an open mind from here and would be inclined to fade any substantial move in either direction.

As for the "Gas" part of this piece, since exiting my natural gas position on June 20th I've been patiently sitting on my hands waiting for another crack at it. With this sector and the price of natural gas now down over 20% from their recent highs, my patience has worn thin. I dipped my toe back in on Thursday afternoon, buying one of my favored domestic natural gas E&P names. As usual, the plan is to pump up the position should investors continue to bail out of the sector.

Disclosure: The Rubbernecker is happy to once again have a little gas.