New Trade $GOOG – Online Advertising Not Enough to Sustain This Behemoth

by Enis December 3, 2012 11:58 am • Commentary

Google is my favorite company as a user.  I use all of their applications for free, and even their advertising is minimally intrusive.  Unfortunately for the company’s bottom line, online advertising has become less and less lucrative over time.  Online advertising rates have been steadily declining for the past year, as advertisers question the effectiveness of online display ads in particular (while video advertising has gained more traction).

As much as Google has tried to diversify their revenue base, it is still dominated by advertising revenues (95% of non-Motorola revenues are advertising revenues).  Reading through the most recent quarterly release, GOOG management’s concern about its over-reliance on advertising comes through from the tone of its comments.  Despite its numerous investments in various businesses in the past 5 years, GOOG is still basically a bet on online advertising growth.

And therein lies the problem.  GOOG has the perpetual difficulty of generating revenues from their service businesses that they currently offer for free.  When your price starts at 0, it’s very hard to change the psychology of your user base to be willing to pay for those services at a later date.  As with many internet businesses, monetization is even a problem for the largest internet company in the world.

Meanwhile, Google’s expenses continue to grow with its foray into cool, but non-revenue generating ventures.  The company risks becoming the new Microsoft, wasting its profits from its bread-and-butter business on new, unprofitable side projects.

How much of this risk is priced into the stock here?  

The stock is trading around 21 times 2012 earnings, which doesn’t seem too expensive given forecasts for 15-20% earnings growth in 2013 and 2014.  But GOOG had its first negative YoY quarterly earnings report in its history last quarter.  And those online ad trends don’t seem to be improving.  Those 35 out of 45 Wall Street analysts with a Buy rating (the other 10 have a hold) on the stock might just be too optimistic in those forecasts.

On the technical side, I laid out my thoughts in the CotD post on Thursday, Nov 29th.  Here is a shorter-dated chart which demonstrates the importance of the 200 day ma as near-term support.



I think the $700-$710 area will hold as resistance on this counter-trend rally, which means, timing wise, this level presents a good bearish entry .

Trade: GOOG ($699.00) Bought the Jan13 680 / 640 / 600 Put Butterfly for $6.00*

-Bought 1 Jan13 680 put for $16.20

-Sold 2 Jan13 640 puts at $6.30

-Bought 1 Jan13 600 put for $2.40

* the bid / ask is wide, I used a limit order inside the offer and got filled, I never pay full bid / ask on a multi-leg structure like this.

Break-Even on Jan Expiration:

-Profits between 606 and 674, with a max profit of $34 at 640 on expiry
-Losses between 674 and 680 and 606 and 600, with a max loss of $6.00 above 680 and below 600 on expiry
Trade Rationale:  I chose Jan13 expiry because it should capture the earnings event on the day of expiry.  However, I don’t plan to hold the trade until earnings if the stock falls according to plan.  Rather, I wanted to use the butterfly structure as opposed to a normal 1×1 put spread because I don’t want the trade to decay much over the next month.  Since we have mostly bearish bets on the site right now, I don’t want to take another purely bearish bet, especially one that would decay.  The butterfly should hold its value much better since Jan13 expiry will capture earnings, and if the stock does immediately fall, then I will have a winner on my hands and might take it off early then.