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Tuesday, September 26, 2006

Google's Achille's Heel, Online Advertising

The growth of Google has depended almost complete on the increase in internet advertising, especially keyword search revenue. But, according to EMarketer, advertising revenue online will not grow as fast as it has in the past, slowing to a rate of 26.8% this year.

Another study from the Internet Advertising Bureau showed online revenue up 36% in the first half of the year, but second quarter revenue up only 5.5% over the first quarter. Search-related advertising grew faster than other categories, up 40%.

According to the Google 10-Q, revenue at the big search company went from from $1.384 billion in the second quarter of 2005 to $2.246 in the same quarter in 2006. For the first six months of the year, revenue rose from $2.641 billion to $4,709. Google makes a point in the document of saying that 99% of its revenue come from advertising keywords.

Yahoo! has already shown that large search companies are not immune from a slowing in internet ad revenue. But, Googles turn may be next.

The math of Google's growth is now set against the math of the overall growth of internet advertising. With new data in hand that online advertising revenue growth is slowing to 35% to 40% range, Google's growth rate of nearly 100% year-over-year must almost certainly come down. The company's share of online revenue is too large to support a theory that it can take huge revenue share from MSN, Yahoo!, AOL and the rest of the online advertising pot to make up for the slowing market.

At a price of over $400, Google's stock valuation is already at fifteen times revenue. And, the company's forward P/E is 31. The stock has run up from $370 in early August.

Google does not have to miss Wall St. estimates by more that a small fraction to undercut the stock's value.

Douglas A. McIntyre can be reached at He does not own securities in companies that he writes about.

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