Google has its display advertising beachhead with its acquisition of DoubleClick, but now the real fun begins: The integration and the profit margin risk.
In a research note Tuesday, UBS analyst Benjamin Schachter cut his earnings, revenue and margin estimates based on the usual suspects: A slowing economy and monetization worries. However, Schachter added a new wrinkle: Falling profit margins due to the DoubleClick purchase.
"Nearterm, we're also cautious on DoubleClick, which we view positively longer-term but expect will pressure margins over the next several quarters," says Schachter. "While the company has many mid-term potential catalysts (increased display, mobile, and offline ads), we believe Google needs to prove that it can execute beyond text-based ads."
Schachter's bet: Google won't be able to be an instant display advertising juggernaut. In other words, it will take longer than most folks think for Google to storm the display advertising world like it has in search ads.
While we believe that the growth potential for display advertising is very meaningful, we believe it hinges on improving targeting from today's levels. Many before Google have attempted to improve targeting and relevance in display and Google's ability to quickly assume a dominant position in this new business is not assured. Historically, display has tended to work better as an awareness-generating medium rather than a pay-for-performance model (the latter historically being Google's strength). While display advertising is certainly a complement to Google's core Adwords platform, there are many important structural differences in the display business that will require Google to assimilate varying constituent objectives, incentives, and technologies in ways they may not have had to with the roll-out of Adwords. We believe it will take some time before the DoubleClick deal will positively impact Google's overall business.
The bigger backdrop here is the economy. Google is acquiring DoubleClick just as the economy slows down. The consensus view dictates that display advertising will slow more than search ads. Schachter's EBITDA margin forecast for 2008 went from 58.6 percent to 56.7 percent and earnings went from $20 a share to $18.99 a share. DoubleClick is a big part of that.
Meanwhile, Wall Street is awaiting comScore's latest paid-click data. Piper Jaffray analyst Gene Munster tracked 400 searches for Yahoo and Google and has determined that paid click ads for February improved from January but are likely to be flat to up 5 percent. "We believe the first two months of comScore paid click data (out after the close) will show an improvement (qtr tracking flat to up 5%), but still suggest a revenue miss for Mar (Street at up 8%)," says Munster.