Are the days of silly AdSense deals with the likes of MySpace and AOL over for Google? Bernstein analyst Jeffrey Lindsay seems to think so. The analyst upped his price target to $600 for Google shares on the theory that the economy is rebounding and the search giant's revenue per click ratio will follow. Meanwhile, Google's profit margins are likely to go higher.
And Google's ability to walk away from high-cost AdSense deals are one reason those margins are headed higher. Lindsay writes in a research note:
We also expect that Google will be increasingly prepared to walk away from unfavorable AdSense for search and AdSense for content deals in the future and this "mix shift" will also translate into higher margins. Rather than agree to revenue guarantees and exceptionally high TAC rates to partners such as AOL and MySpace, as it did in the past, we think Google will simply pass on these deals and allow a much larger share of this low margin and loss-making business to go to competitors such as Microsoft. This may result in some sensationally negative headlines such as "Microsoft scoops the Xyz deal from Google," but much of this business is either uneconomic or toxic or both. For example, consider Google's recent write-down of $726 million attributable to the "strategic investment" tied to the AOL AdSense for Search deal.
Lindsay's take is quite believable. Google has propped up MySpace financials in recent years with $900 million in guaranteed revenue through 2010 even though it has had trouble monetizing that inventory. The best move for Google may be to let a rival like Microsoft win a deal like MySpace.
There's a decent bit of evidence that Google is already being more selective. Time Warner indicated that it may buy Google's AOL stake back as the media giant plans to spin off AOL. And it's highly unlikely that Google will renew its MySpace deal on the previous terms, much to parent News Corp.'s chagrin.
Other odds and ends from Lindsay's research note:
An economic rebound in the second half will reverse negative trends in revenue per click rates. That rebound should give Google's fourth quarter revenue growth of 14 percent.
Paid search has become a proxy for the economy. Lindsay writes:
We believe that paid search is almost unique as an advertising format in that it has no formal contracts and is sold in a real-time electronic auction for search terms. As such, we believe that it will recover almost in real time as the economy improves – so much so that it will in many ways behave like a barometer of economic activity in key sectors such as automobiles and travel. The majority of display advertising does not have these same characteristics because it is sold by sales force and negotiating a new contract typically takes 4-6 weeks per client – generating a significant lag effect. As a result we think the rapid recovery will be almost unique to paid search businesses.
New CFO Patrick Pichette is bringing a new focus on expense control at Google and that discipline will translate into better profits.