The optimists are out there saying that Google should get a pass on its earnings miss today. After all, it only whiffed on analyst non-GAAP consensus of $1.76, turning in $1.54, because of a higher-than-expected tax rate. In the absence of that higher-than-expected rate Google would have turned in …. $1.78. Q.E.D.
Fair enough, but it begs two questions:
- Why was the tax rate higher than expected?
- How would the street have responded if Google had only met expectations?
Second question first, Google has preconditioned investors to expect blow-out quarters. Fairly consistently since going public, super-Google has leaped analyst consensus estimates with a single financial bound. Someone can correct me if I’ve got my history messed up, but in what is now seven quarters as a public company, I’m reasonably sure this is the first quarter where Google would have only met expectations.
While turning in giant percentage profit improvements might seem enough to keep caviling analysts at bay, it isn’t. Why? Because as Andy Kessler points out in a piece from last spring (on a different subject), if you don’t have that last penny to meet/beat consensus then you are out of financial ammo, which investors interpret as meaning “It’s all over.” It’s admittedly not all over for Google, but it is worth noting that the company had no smoothing ammo left, or didn’t deign to use it.
Now, returning to the first point — why the tax rate was higher than expected — Google doesn’t make that question easy to answer. Here is CFO George Reyes doing obfuscatory tax-talk on the conference call:
[Tax rate] estimates are complex, and 2005 was the first year we realized any reduction to our effective tax rate as a result of profits earned overseas under our international structure. At the end of the year, we must true up the tax provision for the year, which could, and in the case of Q4, did have a disproportionate impact on the fourth quarter.
In calculating our true-up for the year, a portion of expenses allocated to international operations was greater than we expected. Primarily as a result of this, a greater percentage of our profits were taxed at a higher domestic tax rate, which resulted in a greater effective tax rate compared to our expectations.
Basically, Reyes is saying that Google spent more than it planned to on its international business, and there wasn’t corresponding international revenue to match against it. As a result, it had a higher percentage of its income in the U.S., and that meant a higher overall tax rate.
Okay, but why didn’t international perform? I mean, Google had to know it was “over-spending” internationally. Here’s Eric Schmidt’s canned response to that question when asked it twice on the call:
We think the opportunity ahead of us particularly in international markets is just exceptional. And what you are seeing is the investments that need to be made to sort of harvest that opportunity.
Fair enough. Eric’s basically saying “trust us”, we’re spending madly on international markets, but we know what we’re doing. It’s not a terrible answer, but it’s also one that requires more faith in a young public company than some people might feel inclined to offer.
Last point: What will be interesting, I think, is to see if this big slide tonight changes the sociology of Google stock. It had turned into a kind of Nifty Google-y, a one-decision stock (buy!) for many investors who had otherwise abandoned technology. It doesn’t take many big downbound moves like today’s to convince a significant part of your fawning constituency to move along to the next pretty girl.