Friday, March 03, 2006


It was amazing to see the market's reaction earlier this week to comments from the CFO of Google regarding its future growth. Mr. Reyes acknowledged that the firm will need to find additional sources of revenue growth, and the stock fell 14% in intra-day, ending up down something like 7% at the market's close.

Obviously, this news was a big negative surprise for many investors. But how shocking can it really be to learn that a firm which has launched so many "free" services just this year believes it needs to find new sources of organic revenue growth?

I confess to still not fully understanding the profitability dynamics of Google. Fortunately, my own investment selection approach requires several years of actual performance in order to qualify as a candidate for inclusion into my portfolio. But generally speaking, I don't buy (or sell) what I can't understand. There are several reasons for this, one of which is best illustrated by the following story.

In the late '90s, I co-managed a venture with a hedge fund group. My role was the management of a static long-short version of my current equity strategy. In this capacity, I did marketing and sales work, including appearing with my colleagues at some hedge fund conferences.

On one of these sales trips, we had the occasion to dine with some Californians, among whom was a trustee and member of the investment committee of one of the state's better-known universities. At this time, Julian Robertson's Tiger Fund group had just gone out of business. Not being privy to the details of that group's fall, I opined that perhaps, like Long Term Capital, they had relied on historic correlations among various hedged instruments, and not adequately understood what would happen if their assumptions proved faulty. Upon hearing this, the university trustee exclaimed that that was exactly what had transpired. He then regaled us for some time with his story of hearing Robertson explain what had happened, as the university had invested in the Tiger fund. Essentially, the fund had hired some hot managers to do some hedging which, according to our acquaintance, Robertson himself had said he did not fully understand. The results are now well-known. That particular group made some horrendous bets which became "unhedged" and caused appalling losses which led to the liquidation of the Tiger funds. Apparently, Robertson lost it all by acquiesing to some managers whose approach he did not, in fact, comprehend.

Back to Google. From what I have read for several years, I still cannot fully understand what the revenue engine is for this firm. Can that many people be clicking on ads while using their search engine? Then there is that occasional story about click-fraud in connection with the websites using Google for their advertising.

In any case, Google's recent spread of activities into digitizing books, starting email and chat services, and global mapmaking, suggest to me, as I have written earlier, that they perceive their brand to be somewhat perishable, not to mention their current search engine advantage. Thus, it is not at all surprising to me that their CFO would admit that Google needs new sources of revenue to continue growing.

It makes me wonder how much of the investor interest in Google is purely momentum buying and holding, and how much represents fully-informed shareholders.

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