Analysis: Wall Street Puzzles over Google's New Direction

(Reuters) -- Google Inc, which revolutionized Internet searches with an easy-to-use site, has itself become an increasingly tricky business to grasp.

That issue leapt to the fore last week when the company stunned Wall Street by missing financial expectations for the fourth quarter -- sending its stock into a tailspin and triggering a flurry of questions over what went askew.

Analysts say Google is simply putting its fingers in too many pies. Forays into television, Android mobile phones and music sales in the past two to three years have left the investment community straining to recognize the company.

A surprise drop in Google's search advertising rates in the fourth quarter raised questions about how its rapidly expanding mobile business was affecting its main money-making machine.

With investors still uneasy about Google's proposed $12.5 billion acquisition of smartphone maker Motorola, the earnings disappointment underscored a big challenge facing Chief Executive Larry Page as he positions the company for new growth opportunities.

Some are wondering if Google has a clear strategy for generating revenue and growth out of a plethora of fledgling initiatives, from Android to its Facebook wannabe, Google+, especially since Page and management refuse to offer guidance.

Right now people are skeptical about those bets paying off, said Walter Price, a portfolio manager at RCM Capital Management, referring to Google's efforts outside its flagship search business.

Google's managers get on a conference call and they're super enthusiastic about their future, and yet you look at the (stock's) multiple and the way the stock is treated, and people don't share that enthusiasm, said Price, whose firm owns Google shares.

Google's stock closed at $569.49 on Wednesday, down from a four-year high of $670.25 earlier this month. The stock trades at 13.6 times forward earnings, compared to the 12.3 average multiple for companies on the S&P 500.

The limited insight Google provides on the details of its non-search businesses has not helped matters, as investors struggle to connect the company's ambitious strategic vision with its income statement.

In that sense, Google is very like Amazon.com Inc, which warned in October it could lose money in the fourth quarter as the online retailer spends heavily on the Kindle Fire tablet and other projects. Amazon is due to report results on January 31.

Google is very much in the midst of a transformation, said BGC Partners analyst Colin Gillis.

Page has taken some aggressive big bets here, stuff that's going to be hard to undo, said Gillis, citing the Motorola deal, which he estimated will lop 600 basis points off of Google's profit margin when the acquisition is completed.

THICKER ARROWS

If Page's bets pay off, search could represent just one of several large and thriving businesses as Google recasts itself as a full-fledged media and services company.

Since replacing Eric Schmidt last April as CEO, the Google co-founder has aggressively tossed out underperforming and non-essential projects and products. The idea is to put more wood behind the company's most important arrows, he has said.

Among those arrows are Google+, the eight-month old social network; Android, the smartphone operating system; and YouTube, the video Website it bought six years ago for $1.65 billion.

Clearly, these have been very successful ventures. Android has become the world's No. 1 smarpthone operating system, surging past Apple Inc's iOS, the software that powers the popular iPhone. YouTube is delivering 4 billion video views per day. And 90 million users have signed up for Google+.

What is less clear is how much money Google can eventually generate from these largely free services, such as from advertising sales.

For Google to keep growing, it needs access to a wider range of content on which it can place ads and make money, particularly as the tech landscape shifts and consumers' Internet habits evolve.

Any walled-off content is the enemy of Google, so they're trying to pry it open. They did it well with Android, they're trying it with social media and they're trying it with television, said MIT Sloan School of Management Professor Michael Cusumano.

The strategy is not cheap, requiring significant investments for Google to build or buy platforms to reach new content -- adding pressure on the bottom line. And many of the new markets may not be as profitable as the search ad business where Google rules the roost, said Cusumano.

Google does not disclose how much money it has spent on Google+. But analysts believe much of Google's aggressive hiring during the past year -- its headcount swelled to more than 8,000 employees in 2011 alone -- was to feed its social efforts as it seeks to challenge Facebook's 800 million user network.

Microsoft's ongoing efforts to displace Google in search provide a stark reminder of the steep price involved in going head-to-head with an entrenched Web company: in the last eight quarters, Microsoft's online services unit has lost roughly $4.9 billion.

Google+, which does not currently feature ads, is still in its infancy and the company has yet to outline its monetization plans for the service. But Macquarie Research analyst Ben Schachter said the benefits of some of Google's other non-search initiatives, such as the vast amount of online video it now streams across the Web on YouTube, are coming into focus.

The goal at the end of the rainbow is TV advertising, he said. For years Google has been eating the lunch of print and radio, but TV has held up incredibly well.

That will start to change by the second half of this year and into 2013, when Schachter expects that TV advertising dollars will flow to online video providers like Google.

TIME FOR A REPORT CARD?

In October, Google said that its mobile business was generating revenue at a $2.5 billion annualized run rate, up from $1 billion a year earlier.

But while the figures provide evidence that Google's mobile efforts are bearing fruit, they leave plenty of questions unanswered, including what portion of the revenue is mobile search ads versus mobile display ads, and how much money is generated from users of Android devices versus Apple iPhones on which Google presumably has to share some of the revenue.

Google's $5 billion run rate for its graphical display ads is similarly murky. And Google's updates on the business are unpredictable: The company has only provided a display ad run-rate figure two times, with five quarters elapsing between the updates.

With mobile and display representing greater portions of Google's business, some say the time has come for the company to be more forthcoming to push its price/earnings multiple higher.

If they want multiple expansion they need to provide more clarity, said National Alliance Capital Markets analyst Mike Hickey. If someone asks them how's an aspect of the business 'terrific' just doesn't cut it anymore.

It is, however, unlikely that Google will go so far as to provide financial forecasts -- a practice the company has shunned since its earliest days.

But more consistent and detailed reporting of some of its key businesses could bolster Wall Street's faith in the company's prospects outside search, and quell some of the persistent anxiety about its spending.

We need a report card, said RCM Capital Management's Price, noting that he believes Google's current search business is only the tip of the iceberg when it comes to the company's longer term money-making prospects.

(Editing by Peter Lauria, Edwin Chan and Bernard Orr)