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What do Google's earnings tell us about the FTC/EU review of Google-DoubleClick? and Google?

In addition to delivering another spectacular quarter of revenue growth, Google provided some new and current information that is highly relevant to the FTC and EU review.

First, compelling evidence of Google's market power is mounting.

  • Google continues to take massive market share rapidly, which is evidence of market power and network effects.
    • Google's over all revenue growth of 57% was more than double the already torrid 27% growth of the online advertising industry overall per IAB. 
    • Google's revenue growth from its pure Google.com sites was even higher, 68%, or 150% faster than the industry at large.
    • That amazing amount of out-performance and separation is far from normal and is not found in competitive markets of this size -- indicating that market power and network effects are at work.
  •  Google's pricing power is increasing
    • Google's reported numbers and answers to questions told us indirectly that Google is effectively raising prices on its Adsense customers
    • While Google uses the euphemism "Traffic Acquisition Costs," TAC is also conversely a proxy for the price that Google extracts from its Adsense customers.
      • Google said in its earnings release and in Q&A, that TAC percent of revenue share fell -- indicating that Google is having to share less of its collected revenue with its customers, in other words, Google's Adsense price is going up. 
    • To take massive market share quickly like Google is currently doing, would normally require deep price discounts to accomplish.
      • The fact that Google is taking massive market share while it is also raising prices is pretty compelling evidence of Google market power
    • Moreover, if you look at Google's 3Q07 earnings slides they show that Google traffic aquisition costs have fallen 20% in less than 3 years; conversely that means the price they have been able to exract from their Adsense partners has increased 20% in less than three years. 
  • So what?
    • Gaining market power and raising prices is not an antitrust problem unless it is actively used to thwart competitors. 
    • The merger review standard for the Google DoubleClick merger is tougher however, because the standard is that a merger should not "substantially lessen competition." 
      • The FTC and the EU have to analyze whether or not adding together the #1and #2 networks of: Internet viewers, advertisers, publishers and consumer clickstream databases would "substantially lessen competition."
      • It seems pretty obvious to little ole me that taking a company like Google, that can't be caught by Yahoo, Microsoft or anyone else in search, is only going to become harder to compete with if they can substantially increase the barriers to competition in four dimensions at once: audience size, advertiser reach, publisher reach, and customer targetting data. 
      • In other words, will the acquisition of Doubleclick only make Google more impossible to compete with? YES.

Second, Google is quickly becoming a global/international company. 

  • International revenues are 48%, up from 39% just two years ago. Google is likely to garner more than half of its revenues from overseas in less than a year's time. 
    • Google CEO Schmidt boasted on the earnings call that: "We do better and better in almost every country." 
  • So what?
    • Most investors think they only have to worry about the FTC blocking the Google-DoubleClick merger. Not so.  
    • They also have to worry about the EU potentially blocking the merger next February. 
      • With about as many Google and DoubleClick users and customers in Europe as in the U.S., and with Google market shares much higher in Europe than in the U.S. (Germany 90%, Spain 90%, France 75%, UK 75%, vs 65% in US) Europe has as much or more at stake in this merger as the U.S. 
    • I believe the EU review is real and clearly more serious than the FTC review; if the merger is ultimately blocked -- it is more likely to be blocked by the EU than by the FTC.

Lastly, is Google Empire Buliding?

  • Apparently the only thing growing faster at Google than revenues is Google's headcount.
    • Headcount has grown 70% over the last year compared to 57% for overall revenues.
    • This is truly remarkable for a capital-intensive technology infrastructure company that enjoys potentially unprecedented economies of scale and scope and network effects.
    • One could make a case that for a company that obsessively automates most everything, they could probably get by with less employees than last year not more. 
  • Google's topline growth is truly awe inspiring.
    • Unfortunately Google's control of spending and the bottom line for shareholders is far from inspiring.
    • It is clear from Google's IPO, when public shareholders were only granted 1/10th voting rights per share, and when they were told Google would not operate for the short term or give forward guidance, that Google clearly intends to spend its free cash flow as its founders see fit.
      • Google appears to be emulating its chief global rival Microsoft, in that it is more interested in building the Google empire than generating shareholder returns.
      • The disconnect will eventually come when the market realizes that Google has no intention to control expenses as the investment community wants. 

Bottom line: There are stories behind the Google earnings story.

  • Google's market power and pricing power are increasing.
  • The EU is the antitrust regulator to watch on the Google-DoubleClick merger -- not the FTC. 
  • And Google is well on path to become the next leading serial empire builder.    

 

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