Return of the $400 Call

Google slips as Prudential goes Hank Blodget on the shares.
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Updated from 7:32 a.m. EDT

Price collided with earnings at

Google

(GOOG) - Get Report

, where a fourfold profit improvement met a stock price that has risen by nearly the same factor.

Despite Wall Street's best efforts to keep the party alive, shares of the Internet search giant remained lower Friday, recently trading at $307.37, down $6.07, or 1.9%, from Thursday's close. At $313.94, that close was the stock's best ever.

A bigger selloff was avoided after Prudential became the first firm to set a $400 price target on the stock. Google was well below $300 in after-hours trading Thursday.

The brokerage described Google's second quarter as "extremely impressive" and advised clients to buy the stock on weakness. "While the second-quarter run-up in the stock has brought Google's valuation on par with other Internet companies, we continue to believe that the company will continue to post hyper-growth rates, which will in turn lead to further upside in the shares."

Prudential's previous price target was $284. (For a story on Wall Street's checkered history with $400 price targets,

click here.)

Two factors were fueling Friday morning's weakness. On its conference call, CEO Eric Schmidt and CFO George Reyes both made clear that Google's third-quarter report may not be so hot. Not only is the third quarter a seasonally slow one for Internet surfing and ad spending, but Google's third quarter of 2004 was exceptionally strong because of improvements it made to its search algorithms and because the hype surrounding its planned IPO drew new users to its site.

"I would like to emphasize that Q3 is historically a slower quarter for growth in both advertising expenditures and Internet usage," Schmidt said right off the bat in the conference call. "Last year was particularly strong because of our ability to monetize traffic."

Investors may have been spooked by the prospect of a slow quarter in what has become a momentum stock, or they may have just wanted to cash in on near-term profits. But if they had been paying attention to Google's last earnings call three months ago, they would have heard Schmidt make similar comments, albeit with a little less emphasis.

The other possible factor in the stock's decline may have been caused by confusion in estimates for Google's EPS figure. Google announced a $1.19-a-share profit on the basis of generally accepted accounting principles -- not on the pro forma basis favored by many Internet companies. But the number bandied about before the report was for $1.21, so it appeared Google missed its number for the first time ever.

But the $1.21 figure came from Thomson First Call. According to Thomson's Web site, analysts were looking for a GAAP profit of $1.09 a share and a pro forma profit of $1.21. Factoring in stock options, Google posted a profit of $1.36 a share. Thomson didn't return a call seeking to confirm its numbers.

For its second quarter ended June 30, the Mountain View, Calif., company earned $342 million, or $1.19 a diluted share, on a GAAP basis, up from the year-ago $79 million, or 30 cents a share.

Google said total revenue rose 98% to a record $1.38 billion in the quarter. Net revenue, or revenue excluding the fees from search-engine advertising partners, rose to $890 million, up from $423 million a year ago. Analysts were looking for net revenue of $842.7 million.

Google's revenue grew at slightly faster rates in the second quarter than in the first. Total revenue grew 93% in the first quarter and net revenue grew 109%. The amount of revenue Google shares with its search partners also declined to 35.7% of total revenue, compared with 36.8% in the previous quarter.

In the call, Schmidt hinted that the company is seeing no overall slowdown in search-keyword prices, despite some anecdotal signs to the contrary. "You can always find one keyword where the pricing is correct and another that is underpriced," he said.

"But if you look at the universe of keywords, it appears, to us, correct to say there's significant room for a combination of more advertisers and more demand to cause the prices to rise, which is obviously good for Google," Schmidt said. "There's no evidence now, at least in the aggregate, that we have topped in any major categories of the market."

Schmidt also indicated that some of the more promising new products, such as Gmail and local advertising tailored to Google's popular online maps, will become cash cows. "With adoption rates of Gmail and local search -- which is a huge market -- these should become very, very large drivers of revenue for Google, but they are not today," he said.

Google gave its usual intriguing hints of initiatives in development. The company is close to allowing its blue-chip advertising clients greater access to rich-media ads instead of plain text links, and its ad-sales team has been restructured to better meet the needs of big clients.

The company is also enhancing its offerings with emerging technology, preparing to roll out more features like maps for mobile devices and experimenting with RSS and tagging, two promising new Internet-content technologies. It's also having better luck hiring the staff it needs to develop features, bringing on 700 new employees in the second quarter.

But when it came to financial transparency, Schmidt and his minions retreated under the usual cone of silence. Google again refused to give any guidance beyond the cautious tone concerning third-quarter seasonality.

Analysts, strictly limited to asking only one question each, mostly chose not to waste it on seeking out financial clarity. One rebel who asked the entirely reasonable question of what drove revenue growth in the quarter, was politely told to go pound sand. "Overall, we were delighted at posting 10%

quarter on quarter revenue growth," sniffed Reyes. "Beyond that, we can't give you much color."

And then the castle gates slammed shut for another three months.