GOOG: Q4 Preview, With No Call On Direction, We Offer Protective Structures or Ways to Add Yield

by Dan January 19, 2012 1:30 pm • Commentary

Event:  GOOG ($636) Reports its Q4 results after the close tonight.

-Options market is implying about a 5.5%-6% move for earnings vs its last 4 qtr  average of about 8% and the 8 qtr average of about 7.6%.   GOOG has to be one of the biggest movers in the S&P500 over that time period for companies with market capitalization’s north of $150billion

Q4 Consensus Expectations and Q1 & 2012 Guidance: 

Q4: $8.38b in revs and 10.46 eps

GOOG does not officially give forward guidance, but just in case:

Q1 :$8.434b in revs and 10.09 eps

FY 2012: $36.981b in revs (up 26% yoy) and $44.07 eps (up 19% yoy)

Review of Q3 reported in mid-Oct:

Company beat revs by about $300mil on a $7.2b estimate, and eps estimates by close to 10% on better than expected paid click growth and solid cost controls.

On the Q3 conference call investors seemed keenly focused on new products that had been gaining traction throughout 2011, Merrill lynch highlighted the following in a note to clients on Oct 14th, 2011:

1) strong mobile traction at $2.5bn rev run rate (up 150% y/y) with 190mn activated Android phones, 2) 40mn users of Google+, 3) Chrome user base growing to 200mn from 160mn in 2Q, and 4) top display advertisers on YouTube have increased spending by 7x since 2009.

Recently the company took it on the chin as investors hit the pause button on the less than stellar Q4 results pre-announced by Motorola Mobility (MMI) where the company said it would miss quarterly revenue estimates for Q4 by $500 million on a $3.88billion estimate and sales of phones would be down about 10% yoy in the all important holiday selling season.   This left many GOOG investors wondering what GOOG’s plans were outside of MMI’s mobile patents and what they were exactly getting for $12.5b.

Price Action & Technicals:

GOOG had quite a year in 2011, closing up almost 9% ytd, which masked a great deal if volatility in that time period……The company had a very dramatic Q1 disappointment, followed by a CEO change and then a series of 2 positive earnings surprises that capped a 40% rally off of the summer lows.

1 Yr GOOG chart from Bloomberg LP


Sentiment: Wall Street analysts are overwhelmingly positive on the stock with 34 Buys, 7 Holds and no Sells, with an average 12 month price target of $738.  Short interest sits at just above 1.5% of the float.

Implied Volatility: 30 day implied vol is about 34 which is rich to the 30 day realized vol of about 21 and 60 day realized of ~25….

Valuation:  GOOG currently trades at about 14.5x next year’s expected earnings which is obviously only a slight premium to the S&P and a healthy discount to AMZN‘s 80x . For a company expected to have north of $35billion in sales, it is still displaying some of the best expected growth by most large cap stocks in any sector with 2011 sales and eps growth of 33 and 25% respectively. 


Here is a quick round-up from some influential Internet Analysts:

Citi Mark Mahaney (Buy rated $680 target) From Jan 17th note to clients:

Based on extensive intra-quarter channel checks and our model sensitivity work, we believe
Street Q4 Revenue & Non-GAAP EPS estimates are ballpark reasonable, although in
something of a change, we actually see more risk to Street revenue than to Street EPS
estimates this quarter, due to significant Q/Q FX headwinds. We think FX headwinds
constituted a material 2%+ Q/Q drag on GOOG’s top-line results in the December
Quarter given its significant (50%) international exposure

We anticipate a modest 1-point deceleration in Google’s organic Y/Y Gross Revenue growth to 27%, though off a3-point tougher comp. And we anticipate GOOG’s EBITDA margin to be down around370 bps Y/Y to 55%. We expect deleverage to continue to come from the COGS, R&D,and Sales & Marketing lines

BofA Merrill Lynch Analyst Justin Post (Buy $720 target) in a note to clients Jan 18th:

Expect solid results, paid click upside in 4Q
Google reports 1/19 and based on our advertiser checks we expect strong 4Q
results (+26% ex-FX revenue growth vs 25% in 3Q) driven by paid click growth
upside (vs. our 25% estimate) on vertical search improvements and mobile
strength. Europe is a potential offset due to macro weakness and FX, and y/y
CPC growth should decelerate. With positive 4Q expectations for the US
business into the print and little clarity on Motorola, Europe, or other issues (see
below) expected on the call, we expect a muted stock reaction to meet/beat 4Q
results (not a big move up or down), with modest changes to 2012 estimates.

Expect 4Q EPS above street, but in-line for 2012
We think buyside is looking for 12% q/q revenue growth and we think Google can
come in in-line. We expect Google to report EPS above street, our $8.27bn/
$10.63 compares to street at $8.41bn/$10.50. US$ appreciation will negatively
impact 4Q and 2012 estimates (a stock risk post results), but Google should be
partially hedged on revs and more hedged on EPS. Given q/q FX pressure, for
Q1’12 we expect flat q/q revenues vs Q4’11 (vs 3% q/q growth in Q1’11). For
2012 we are in-line at Rev/EPS $35.88bn/$44.18 vs street at $36.57bn/$44.13.

Stock issues won’t get a lot of clarity on the call
Key issues are Motorola acquisition (there are new investment concerns given
Motorola’s Q4 miss), competition with Facebook, Google+ usage trends,
regulatory reviews, and margin outlook for 2012. As usual, we don’t expect much
color on these items on the call. Margins will take a large step down in 2012 with
Motorola, although the core business will be reported separately.

MY TAKE:  GOOG is by no means an expensive stock and has a solid balance sheet with almost 20% of their market cap in next cash, with long term growth that clearly seems reasonable for its low teens multiple.  But here is the thing, I am a bit of a contrarian, and I don’t buy stock that everyone loves and almost everyone I know owns trading a few % off of its 4 year highs, and especially into an event like earnings where the stock has been very volatile……

The options move seems priced to perfection to me….with the stock ~$636 the Jan 635 Straddle is offered at about $36, which to break-even you need about a 5.7% move by Friday’s close……On the upside $36 gets you to about the 52 week high of $670 made earlier this month, and on the downside to about $600 which is near-term support.  Sorry to disappoint some of you but I don’t have a directional trade in the name.  I don’t have strong conviction and the margin for error in a name like this is slim around earnings.

There are a couple trades that stand out to me to possibly protect longs, one would be selling an upside call and using the proceeds to buy a Put Spread.   An investor would only do this if they were as worried about downside as they were about participating in upside.

TRADE 1: GOOG $636 [AGAINST EXISTING LONG]  Sell the Jan 665 call to Buy the Jan 620/600 Put Spread for about Even Money. Prices below show that this structure would cost about .40 but for ease of the write up I will suggest it is for even money.

-Sell the Jan 665 Call at 6.20

-Buy the  Jan 620 Put for 10.00

-Sell the Jan 600 Put at 3.40

Break-Even on Jan Expiration (Friday):

Profits: Consider the long stock position and the call that you are short as an overwrite, so you would participate on the upside btwn $636 and $665 with your stock called away at $665.  SO max gain is $29 or about 4.5%.

Losses btwn current stock price of $636 and $620, lose up to $16 or about 2.5%, and gain protection between 620 and 600 (down 2.5% to down 5.7%).  Below $600 your long stock is not protected.

TRADE RATIONALE:  Long holders would consider this trade structure if they want to protect gains, but also want to participate in the chance of any upside following the print.  The big trade off is that you give up some upside to get some near term protection if the stock sells off in-line with the implied move.

If the stock does nothing post earnings or closes above 620 or below 665 than all options will expire worthless and you will be left with your long stock  The only read trade management would occur in the situation where the 620 puts are in the money and you will likely have to sell the Puts if you care to keep your long stock.

Alternative Trade For long’s who:

1. think the stock will underperform the implied move or

2. would be looking to add to a position on any weakness

This sort of strategy would only be appropriate for sophisticated traders/investors who understand the risks with overwrites, or naked short put sales.

TRADE 2: GOOG $636 [AGAINST EXISTING LONG]  Sell the Jan 635 Straddle at ~36.00

-Sell 1 Jan 635 call at 18.00

-Sell 1 Jan 635 Put at 18.00

Break-Even On Jan Expiration:

Profits: if the stock closes btwn 636 and 671, you make the gains of your stock plus the premium that you sold of 36.00, but if the stock closes above $371, up about 6% than your stock is essentially called away at that level.  To break it down your stock is really called away at $635, the call strike that you sold, but you have taken in the $18 in premium from the Put sale, and the $18 in premium from the call sale which gets you to $671.

Loses: btwn $636 and $600 your long is basically protected as you have taken in $36 in premium from the sale of the Jan $635 call and the Jan $635 Put, BUT you have no premium protection below $600, and you actually start to get long at that level. Lets break that down, because you are short the Jan $635 Put  you would actually start to get long below that level on expiration, but because you have taken in $36 in premium from the sale of the straddle that would be offset and the price that you really start to lose money is $600. And you are now longer GOOG stock at 600 than you were beforehand.