Google’s girth worries investors

Times Staff Writer

Should Google be more frugal?

Google Inc.'s shares fell more than 7% on Thursday after investors realized that the Internet giant’s expansion plans are not only ambitious -- they’re expensive.

The Mountain View, Calif.-based company said second-quarter revenue jumped 58% to $3.87 billion as it continued to dominate the search-engine advertising market. But profit rose only 28% to $925.1 million because Google invested heavily to hire employees and develop products.

“They spent too much,” said Jordan Rohan, an analyst with RBC Capital Markets.


Wall Street had been largely content to let Google spend freely to establish beachheads in new markets and acquire companies, as long as it delivered fast growth and big profit.

But when the company’s earnings fell shy of analysts’ expectations, investors sent its shares plummeting $39.49 to $509 in extended trading. The stock closed down 91 cents to $548.59 in regular trading, before the profit report.

Google earned $2.93 a share, up from $2.33 a year earlier. Excluding stock-based compensation and other items, the company’s $3.56 a share profit fell 3 cents short of the Wall Street consensus as measured by Thomson Financial.

During a conference call, analysts grilled Google executives about the company’s unabated hiring binge.


Less than three years ago, Google had 2,668 employees. Thursday it said its head count had reached 13,786 after about 1,500 hires during the quarter.

“We’ve been chronically understaffed,” said Omid Kordestani, Google’s senior vice president of global sales and business development.

“I know that sounds silly. But in fact we’re really doing a lot. When we say that we’re organizing the world’s information and making it useful to people, we really mean it. There’s just a lot to do.”

As a result of the hires, quarterly stock-based compensation expenses came to $242 million and are estimated to be $770 million for the year.


“That’s just crazy,” Rohan said.

Some of those employees came from acquisitions, such as YouTube Inc., which Google snapped up last year for $1.65 billion. And Google plans to absorb more companies.

In April, it agreed to pay $3.1 billion for ad-delivery company DoubleClick Inc. And Google last week paid $625 million for Internet security company Postini Inc.

To the casual observer, Google has been on a helter-skelter spree, expanding into businesses as disparate as e-mail security and online videos.


But Derek Brown, an analyst with Cantor Fitzgerald, said there was a method to Google’s madness.

“Google wants to have services for consumers wherever they might go, online or offline,” he said. “Google also wants to allow advertisers to reach those consumers wherever they might be. They’re casting a wide net, providing functional services where consumers are spending time.”

Google has been busy pursuing what Chief Executive Eric Schmidt calls its three-prong strategy of “search, ads and apps” -- the latter referring to software applications such as its Web-based e-mail, word processors and calendars.

Apart from its core business of delivering simple text-based ads alongside search results, Google also is expanding into other forms of advertising.


DoubleClick, for example, would allow Google to instantly grow its business of delivering banner ads to websites.

But the deal is facing heavy scrutiny by lawmakers and regulators who worry about the privacy implications of combining Google’s database of people’s search queries with DoubleClick’s ability to track Web-surfing habits.

Google also is reaching offline with deals to broker ads to more than 1,400 radio stations, 125 national satellite channels on EchoStar Communications Corp.'s Dish Network and more than 225 print publications, including the Los Angeles Times.

To reach people wherever they are, Google is either developing or buying applications that it hopes people will find useful.


For mobile phone users, it has launched a free directory assistance service and added its popular street mapping program. For users of its e-mail, Google recently bought Postini to better control spam and viruses -- especially to businesses that wouldn’t hire Google to manage their e-mail systems without better security.

Aside from the expense of pursuing so many projects, there could be other costs to Google: quality.

“The risk here is that they may become a jack-of-all-trades and master of none,” Brown said.

But that isn’t stopping Google from investing heavily in technology and manpower.


In the conference call, Schmidt acknowledged that the company had spent more than planned on hires.

“We decided it was not a mistake,” he said. “The kind of people we brought in were so good that we’re glad we did this.”

Many of the new markets have yet to generate meaningful revenue. So what’s paying the bills? Google’s core search-advertising business, which has helped the company stash away about $12.5 billion in cash and marketable securities as of June 30.

Its grip on the search market isn’t about to let up. In June, Google’s share of online searches was 52.7%, up from 49.4% a year earlier, according to Nielsen/ NetRatings. No. 2 Yahoo Inc. trailed far behind with 20.2% of the market, down from 23% the year before.


RBC’s Rohan and others predicted that shareholders, who had sent Google’s shares up 20% this year on signs that it had beaten back all comers in Web search, would calm down once they realized that the quarterly growth slump was probably seasonal -- Internet usage tends to drop in the springtime, especially in Europe, where Google is growing fast.