TCS Daily

Searching for a Way Out of Growing Pains

By Dominic Basulto - November 23, 2004 12:00 AM

In the three months after its eagerly anticipated $1.7 billion IPO, Google could seemingly do no wrong. Starting at $85 in mid-August, the company's stock price quickly rocketed through the $135 mark and briefly flirted with the $200 price point before falling back to the $160-$170 range. Google added to this phenomenal stock price performance with a blowout third quarter, posting a record $805.9 million in revenue, up 105% year-over-year. Almost as soon as some Wall Street equity analysts rushed out to raise their price targets for Google stock, though, Google warned of a revenue growth slowdown in the final quarter of 2004 and hinted of "formidable competition" ahead from rivals such as Microsoft and Yahoo.

Now things get interesting. No longer sheltered from the harsh glare of the public equity markets, Google faces the difficult task of managing Wall Street expectations. While nobody expected the days of triple digit growth rates to last forever, investors do expect that Google will continue to find ways to post double-digit growth rates -- or at least meet consensus Wall Street expectations every quarter.

Just ask companies like Buoyed by strong online sales, Amazon reported a robust 3Q, posting net income of $73 million, compared to $48 million in the year-earlier period. Yet, on the news, investors promptly sold off the stock, sending the stock down 8% in after-hours trading because the company failed to meet consensus Wall Street expectations. Whereas Amazon posted 3Q net profit of 17 cents a share, Wall Street analysts had forecasted a profit of 18 cents a share. The headlines? "Amazon misses by a penny."

It's not only the Internet high-fliers like Amazon, eBay and Yahoo which face this type of insurmountable pressure from Wall Street. Consider the example of Microsoft. The company continues to pile up cash at a rate of $12 billion a year and posts earnings of nearly $3 billion a quarter, but the consensus now is that the company is no longer a "growth" company. As a "mature" company, they say, Microsoft should focus on shareholder buybacks and dividend payments rather than innovative new product offerings.

Google, apparently, recognizes this growth imperative: in just the past three months, the company has rolled out a new Google Desktop Search offering and a Google Scholar search offering. Google also acquired satellite map company Keyhole. There has also been rampant speculation that the company will roll out a Google instant messaging product, a Google TV search product, a Google Internet portal and even a Google Web browser. These rumored product offerings follow close on the heels of new initiatives over the past 12 months related to blogging, social networking, comparison shopping, email, and digital photo sharing. In order to appease Wall Street, the company must quickly turn this grab-bag of beta product offerings into tangible revenue streams.

For now, the hype surrounding these quasi-product announcements have helped to bolster Google's reputation, giving it (as more than one Silicon Valley columnist has noted) a "Wonka-like mystique." Wall Street, though, has limited patience for "mystique" -- it rewards or punishes companies according to one criterion: its ability to "make the number."

Going forward, Google has two fundamental options: organic and inorganic growth. The organic growth scenario assumes that the amazing Google R&D factory will come up with the Next Big Thing to complement the company's online advertising business model. The inorganic growth scenario assumes that the Google earnings machine can no longer generate the kind of spectacular quarter-over-quarter growth that Wall Street demands. In response, Google will have to dip its toes into the acquisition waters and find companies like Keyhole, Picasa or Blogger that can drive additional revenue. Integrating new acquisitions, though, is always dicey -- especially for a young company like Google that places so much emphasis on corporate culture.

Both scenarios assume that, even in the face of increased competition from the likes of Yahoo and Microsoft, Google will continue to control 49% of all Internet searches. With new search competitors seemingly materializing every day, that is a rather bold assumption. With its latest foray into desktop search, moreover, Google is bumping up uncomfortably close to the Microsoft juggernaut, which is girding itself for a bruising battle for Internet dominance. In early November, Microsoft unveiled a beta version of its latest search technology that one day could rival Google's technology.

The real test, no doubt, will come over the next three months. That's when the "lockup period" on nearly 90 million Google shares held by company insiders expires. This number of new shares dwarfs the 20 million shares offered to the public in August. Over the next 90-day period, Google insiders will be free to dump tens of millions of shares for potentially huge profits. Can the market absorb this glut of Google stock? Or will insiders hold on to Google shares, hopeful of even more impressive long-term gains?

After six years as a privately-held company, Google is now facing the types of financial questions that it had been able to avoid before going public. If the company wants to justify its $50 billion market capitalization (about on par with Walt Disney or Merrill Lynch), let's hope that the Google whiz kids Sergey Brin and Larry Page continue to come up with the same innovative brilliance that turned search into one of the most lucrative businesses on the Web.

The author writes frequently about technology and venture capital markets.


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