Google costs in focus after busy quarter

SAN FRANCISCO Tue Jul 12, 2011 3:51pm EDT

An employee answers phone calls at the switchboard of the Google office in Zurich August 18, 2009. REUTERS/Christian Hartmann (

An employee answers phone calls at the switchboard of the Google office in Zurich August 18, 2009.

Credit: Reuters/Christian Hartmann (

SAN FRANCISCO (Reuters) - Google Inc's investment spree and shrinking profit margins will draw investor scrutiny when it reports its earnings on Thursday, following an eventful quarter when the company launched the Google+ social network and the government disclosed a probe of its business practices.

Google has pumped money into a variety of initiatives -- some of which have yet to add to the bottom line -- as it seeks to maintain its No.1 position in the Internet search market and expand into new markets. It is battling heavyweights like Facebook and Apple Inc in social networking and mobile.

The company is gearing up for that battle on a number of fronts, including talent. It plans to hire more than 6,000 employees this year, its most ever, and it gave a 10 percent pay raise to all employees at the start of the year.

Wall Street's reaction to Google's spending last quarter was swift and unambiguous: shares of Google sank 8 percent after the company reported a sharp rise in operating expenses that ate into margins. The company's adjusted operating margin fell three percentage points year-on-year to 38 percent.

"If people can see any sign that the margins have at least stopped declining, then the stock will be good," said Mike Binger, a fund manager at Thrivent Financial, which owns Google shares.

"My hope is that they front-end loaded the spending and they can put up a decent earnings number."

Last week, Google received a rare downgrade from Morgan Stanley, which cited the company's rising expenses. And some investors are bracing for more spending.

"I'm kind of putting my head under my desk about the expense line," said Pat Adams, a portfolio manager at the Dunham Loss Averse Growth Fund, which owns Google shares.

"It's kind of like the employment figures last week, how bad is it going to be?"

CHARMS OF GOOGLE+?

One thing that could alleviate the pressure to curb spending is Google+.

Initial reviews of the social network have been encouraging, raising hopes that the company has finally figured out an effective strategy to counter Facebook's growing popularity among websurfers and advertisers.

It "reminds people that Facebook won't be the only social platform in the world forever, which I think had been the assumption," said Stifel Nicolaus analyst Jordan Rohan.

Since the launch of Google+, the company's shares have increased roughly 9 percent, closing Monday at $527.28, compared to a roughly 4 percent increase posted by the Dow Jones Industrial Average and the Nasdaq during the same period.

In a note to investors this week, Rohan said that Google+ could prove to be the company's first "big hit" with Larry Page as CEO, and that its success "could sway investor focus from initiative spending toward product results."

Since taking the reins in April, the 38-year-old co-founder has streamlined decision-making at the upper ranks, placing a handful of executives directly under his supervision.

But the media-averse Page said only a few words on the first-quarter conference call before signing off, provoking grumbles among investors who had hoped he would take the opportunity to outline his plans.

Google would not comment on whether Page, who co-founded Google as a Stanford graduate student, would participate in Thursday's conference call.

Investors polled by Thomson Reuters I/B/E/S are looking for net revenue, which excludes fees Google pays to partner websites, of $6.54 billion in the second quarter, up 28 percent year-on-year and flat from the first quarter.

According to StarMine's SmartEstimate, which places more weight on recent forecasts by top-rated analysts, Google should post adjusted earnings per share of $7.76, 10 cents beneath the average analyst expectation for EPS of $7.86.

The earnings report comes as regulatory scrutiny surrounding Google has intensified. Last month the company disclosed that the Federal Trade Commission was investigating the company's practices in search and advertising.

Investors are hungry for details about the probe and clues as to whether Google will seek to settle the matter quickly or risk getting drawn into a protracted fight with the government, as software giant Microsoft Corp did.

But with the investigation in its early stages, and any potential regulatory repercussions for Google likely to be years away, many investors are not losing sleep over it.

"As an owner of Google there's an order of concerns," said Thrivent's Binger, citing items like the health of the online advertising industry, profit margins and competition. "The FTC investigation would not be in those top three."

(Reporting by Alexei Oreskovic; Editing by Phil Berlowitz)

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