Google Paid Clicks – Is the Slowdown Cause for Concern?

Last week, Google (NASD:GOOG) shares suffered a precipitous drop after comScore released a report showing that paid click growth for February had slowed to 3% over the same period last year. This followed a weak January, when clicks dropped 8% from the December holiday shopping period.

The reports have raised concerns about Google’s Q1 forecast and, more generally, whether online advertising would be dragged down by the weak U.S. economy. Comparing the 3% gain to the 30-40% gains Google had seen in 2007, Bernstein Research analyst Jeffrey Lindsay said

We think that these higher earlier growth rates reflected Google’s large search share gains over Yahoo! and Microsoft at that time and also paid search’s gains over display advertising – two sources of incremental growth that are now maturing. Now we believe the primary driver of Google’s paid click growth is the fundamental shift of offline advertising to online.

Overall, Lindsay remains bullish on the stock, noting that Google’s key metrics all improved for the month, with click-through rates and paid click per search with paid ads each improved.

Google has explained the drops by pointing to the reduction in what is known as coverage ratio – the number of ads displayed with each search. In recent months, Google has implemented a series of changes to combat what it refers to as low quality ads. Google has added a quality score which is used to determine whether an ad is displayed, along with its position on the page. While this may have the short-term effect of reducing the coverage ratio, Google believes that it will result in higher click-through rates, thereby increasing the value of keywords. Yet response on the Street and in the markets suggest concern over the time it may take for the benefits of the improved quality to offset the reductions in click-throughs.

Following a Friday conference call with comScore and ChannelAdvisor, Citi Investment Research analyst Mark Mahaney cut his estimates for Google, while maintaining a buy rating and a $590 price target. His 2008 revenue estimate dropped from $16.0 billion to $15.6 billion, while his earnings forecast was cut to $19.08 per share from $20. Those numbers were based upon 2008 forecasted paid click growth of 16% year-over-year and 0% Q1 growth quarter-over-quarter. According to Citi’s model, every 1% change in quarter-over-quarter paid click growth translates into a $35-million swing in net income.

Meanwhile, BMO Capital Markets analyst Lee Westerfield suggests the real concern in the comScore numbers was the modest growth in queries. “The new concerning datapoint for Google in February is the sharply slower growth for Google in Queries (+29%), raising the level of concern that Google search hyper-growth and momentum is at last maturing.”

Piper Jaffray analyst Gene Munster remains bullish on GOOG with a price target of $790. Pointing out that his checks with search engine marketers have not revealed any weakness in paid ads, he notes “The second month of comScore gives us further evidence that Google will fall short in the March quarter. However, we believe the magnitude of the shortfall will not be as bad as the comScore data is suggesting.”

Yet American Technology Research analyst Rob Sanderson (courtesy Silicon Alley Insider) thinks that many are getting the Google picture wrong.

While most analysts and investors agree that quality improvements will bring along price improvements, there is concern about magnitude and timing. We believe that higher prices will completely offset lower volumes and that the timing will be immediate.

Sanderson points out that the focus should be on ecommerce conversion rates, not on the specific numbers of click-throughs. Advertisers pay for transactions, not for clicks. Improved quality should immediately lead to advertiser willingness to pay more for the higher-quality clicks:

We believe this move will be close to immediate . There are two reasons why we make this claim: 1) GOOG is an efficient marketplace – there are hundreds of thousands of advertisers that bid on Google keywords and 2) improvements in conversion rates and ROI are measureable – this is the mantra of GOOG. We also believe that GOOG management knows what they are doing and would not intentionally slow revenue growth.

Sanderson, who rates GOOG a buy with a $750 target price, sees the current dip as a strong buying opportunity.

Technorati Tags: (GOOG), Comscore, Google, internet, internet-advertising, online-advertising, research-roundup

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Tuesday, April 1st, 2008 : Equity Research : No Comments

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