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Google 'Mystique' Still Strong?

The Google mystique remains strong with consumers, as the search giant's traffic and revenue grew again this quarter. But shares fell 4.76 percent in after-hours trading, as the Street pondered warnings of a third-quarter slow-down.

Google reported record revenues of $1.384 billion for the quarter ended June 30, 2005, up 98 percent year over year. Google didn't subtract its $434 million traffic acquisition costs from that number; such costs include the amount of ad revenue it pays to partners that run its ads on their sites. Net income was $343 million, or $1.19 a share, compared to revenue of $79 million, or $0.30 a share, for the previous quarter.

Revenues in the second quarter totaled a record $1.384 billion, a 98 percent increase year-over-year; however, revenue grew only 10 percent from the previous quarter. Google-owned sites accounted for 53 percent of total revenues, while AdSense advertising generated 46 percent.

According to Web traffic monitor Nielsen/NetRatings, Google ranked No. 4 in traffic volume in June 2005, attracting more than 78.5 million U.S. visitors that month. It was first in search, handling 48 percent of all searches conducted in May. Archrival Yahoo drew 99.3 million unique U.S. visitors in June, Nielsen said.

After telling analysts on a conference call, "We don't give guidance," Google CEO Eric Schmidt warned the Street not to expect the next quarter to match the third quarter of 2004. "Q2 and Q3, particularly Q3, are historically a slower quarter for both Internet traffic and ad spending," Schmidt said.

Last year's third quarter was buoyed by excitement at Google's IPO, he said. Moreover, the search giant's European operations contribute a growing amount to the bottom line, and business there slows in August as people head for the beach.

"As you contemplate your third-quarter estimates," Schmidt said, "I encourage you to factor in seasonality, as well as the increasingly large contribution from Europe."

Last quarter, Google's ad revenue began to fatten with what David Jackson called "a can't lose" proposition: CPM advertising on other publishers' sites via the Google AdSense program. Jackson, an independent stock analyst and editor of the Internet Stock Blog, said such advertising, in which the advertiser pays a set rate per thousand times the ad is shown, as opposed to clicked on, lets Google sell to brand advertisers such as automakers, that aren't looking for an immediate response.

"Many people in the financial community said they thought the whole idea and beauty of Google was to get away from CPM-based ads," Jackson told internetnews.com. "That misses the story. The story is what Google is really about is intelligent optimization of advertising for both advertisers and publishers."

On the conference call, Google co-founder Sergey Brin said, "Our CPM system is distinct: Advertisers still pay only the minimum price needed to run an ad on that site."

That intelligent optimization means Google applies its algorithms to determine whether it can collect more money for an AdSense ad, which appears on a wide variety of blogs and Web sites, by displaying a CPM display ad or a pay-per-click unit.

"CPM-based ads have no downside for Google," Jackson said. "They only run a CPM ad if it will make more money than a [pay-per-click] ad."

ThinkEquity analyst John Tinker sees evidence that Internet advertising may continue to grow by snaring ad spends from television and magazines. Tinker pointed out that even though Internet advertising accounted for only 3 percent to 4 percent of the estimated $10 billion to be spent in 2005, it's already having a "substitution effect."

"Historically, network TV has been the first one on the list [of media buys] followed by cable," he wrote in a research note. "Procter & Gamble, the largest advertiser in the United States, has reduced its budget for TV ads in 2005. It is estimated that it would spend up to 25 percent less on cable channels and 5 percent less on broadcast networks."

He's set a $330 price target for GOOG. Nevertheless, he wrote, "We would suggest that the so-called 'easy money' has been made, as the stock is no longer institutionally underweighted and now appears to be better understood.

In the same way that Google was oversold on its IPO, it now may become "overbought" as the company appears to be building a 'mystique.'"