"How can we not be happy?" Google ( GOOG ) CFO Patrick Pichette asked rhetorically last week as the Internet search giant unveiled stellar earnings and revenue for the fourth quarter and full year 2010.
He got his answer: a swift $28 drop in Google's stock price. Shares closed Thursday at $616 and change.
On the face of it, Google management and shareholders had plenty to celebrate. In the fourth quarter, sales surged 26%, profits rose 29%, profit margins increased to 40% and operating cash flow was $3.5 billion -- all above Wall Street's expectations. Growth in Google's core search business accelerated, and Pichette stressed that newer businesses in display and mobile search were "another growth engine" for the company. Analysts rushed to increase their one-year stock price targets, with some going as high as $800 a share.
So why the tepid response?
The elephant in the Google press briefing was barely mentioned: Facebook. Google's news came in the midst of Facebook's controversial private placement, in which Goldman Sachs Group and a Russian investment firm invested $500 million on terms that valued Facebook at $50 billion. But the metric that seems to have caught the attention of many investors is that Facebook surpassed Google as the most-visited website in the U.S. In other words, Google's real competition isn't other search engines like Microsoft's Bing or Yahoo. That war is largely over. Nor does Facebook currently face much of a threat from other social-networking sites. What's shaping up is a monumental Google-Facebook showdown to win the hearts, minds and wallets of Internet users worldwide. As one person in California told me, "If I were Google I'd be quaking in my boots."
This has apparently been obvious for months in Silicon Valley, where the two companies have been in an arms race to hire talent. But the catalyst for this realization reaching a broader public seems to have been last week's surprise announcement that Google co-founder Larry Page will replace Eric Schmidt as chief executive. Under this scenario, the visionary Page rather than the seasoned manager Schmidt was urgently needed to combat the threat from Facebook, which is controlled by 26-year-old wunderkind Mark Zuckerberg. Google couched the announcement in terms of management clarity and efficiency ("We'll operate and execute even better" in Schmidt's words), but the real need is to reestablish the entrepreneurial drive that is propelling Facebook.
How will Google and Facebook compete? The goal of each is to be the point of entry for users of the Internet, the theory being that whoever controls the gateway ultimately will deliver the most effective advertising platform. As I discovered in reporting for my column last week, Facebook is so important to some users that it's on their computer screens 24 hours a day, seven days a week. I feel like I'm constantly using Google, but I don't sleep with it.
Exactly how this competition will unfold remains to be seen. Last week Google co-founder Sergei Brin remarked that what's been done already in Social Search, Google's social-networking feature, is "just the tip of the ice berg" and represents only "1% of the capabilities that can be deployed in that realm." This is obviously one of the areas he'll be targeting in his new role as head of strategic projects.
So does the rise of Facebook threaten Google's robust profit margins and stock price?
Many investors seem to think so, judging from Google's decline this week. But my sense is the competitive landscape is much more dynamic and complex. Google may be facing the first serious competition in its thus far charmed life, but this isn't necessarily bad for either Google or Facebook. The market isn't static. As Google's Pichette noted, there are "huge opportunities for innovation and growth at Google as well as the entire ecosystem."
As I said last week, I wish I were a Facebook shareholder, but I'm not a member of that exclusive circle. I have been a Google shareholder since its public offering, and in my experience, widespread doubts about Google have often been an opportunity to buy. With a forward price/earnings ratio of 15.5, Google is priced like a value stock.
For now, I say let the competition begin. I hope Page is right when he said last week that "our computing life is still at the very early stages…we're really only at the beginning. I can't wait to get started."
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