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Google Making Strides in Emerging Businesses

Google's second-quarter financial report last week provided further signs that, after years of trying, Google may finally be seeing material results from emerging businesses that could help it diversify from search advertising, which still generates most of its revenue.

Google executives on Thursday said that the company has made significant progress in growing its three main emerging businesses -- display advertising, mobile advertising and hosted workplace software.

Some financial analysts are also becoming convinced that this is so, although Google doesn't break out its revenue in a way that lets outsiders know the specific revenue figures for those emerging businesses.

Google's revenue engine has always depended on search advertising -- a highly profitable, large and vibrant segment of the broader online advertising market that the company has thoroughly dominated.

But while search advertising has fueled Google's stellar financial performance, the company has been criticized for depending on it too much, with some calling Google a one-trick pony.

The implication is that if a competitor builds a better search advertising mousetrap, Google could suffer a major financial blow. Critics also question how long Google can remain on a revenue growth path while depending so much on search advertising.

To Google's credit, the company has been planting seeds for years in other markets. While some of those have failed to sprout, display advertising, mobile advertising and hosted workplace software seem to be blooming for the company.

Financial analysts, through their own research and calculations and from Google executives' comments, seem fairly certain that the opportunity in these emerging markets is real.

Citing Google's better-than-anticipated 24 percent year-on-year revenue increase in the second quarter, Barclays Capital analyst Douglas Anmuth wrote in a research note that "the growth suggests to us that newer initiatives like display -- and to a lesser extent mobile -- are gaining traction and beginning to impact numbers more."

Citigroup analysts credited particularly strong revenue growth in the U.S. to three factors, one of which was the effect of display and mobile advertising "becoming more material to Google's total revenue and growth."

Ben Z. Rose, president of Battle Road Research, estimates that Google is on track to generate between US$500 million and $700 million in display advertising this year. "It seems YouTube is doing extremely well," he said in an interview, referring to the video sharing site that is a key component of Google's display ad business.

Rose is also confident that Google will do well in the hosted workplace applications space. "Between their core market and making headway into some of these new platforms, as well as the international expansion they have, assuming the economy holds up, we think Google can grow at 20 percent-plus [revenue] per year," Rose said.

On Thursday, Google Chief Financial Officer Patrick Pichette and other Google executives rattled off a litany of stats to support their enthusiastic statements about the growth in these three emerging areas.

YouTube, increasingly attracting big-name marketers like Sony and Coca-Cola, generates 2 billion views per day, and the monetization rate of the site is on the rise, they said.

About 160,000 Android-based phones are activated every day, up from 65,000 per day in the first quarter, and there are now 70,000 applications in the Android app store. Search queries on Android devices grew 300 percent in the first half of 2010, they said.

The Google Enterprise unit keeps landing major accounts for the Google Apps suite, as the company competes against the likes of IBM-Lotus, Microsoft and others. Google charges $50 per user, per year for Google Apps Premier.

Perhaps more significantly, Pichette said that, along with the core search business, these three emerging areas are being invested in aggressively in various ways, including through staffing boosts, specifically of engineers and salespeople. In the second quarter, Google added almost 1,200 full-time employees to its global staff, more than in the previous two quarters combined.

Google, which this year has bought 15 companies, with two more deals in the process of closing, is also boosting its emerging businesses through acquisitions: DocVerse, acquired in March, is intended to boost Google Docs and Apps; the $750 million AdMob deal, which closed in May, is meant to boost mobile advertising; and Invite Media, bought in June, should boost display advertising.

It will be interesting to watch in coming quarters whether the diversification of revenue becomes more pronounced or instead loses steam, a possibility if Google fails to measure up to the formidable competitors it faces in each of these emerging businesses.

With Google betting on these emerging businesses with considerable investments, a failure to compete successfully could have a noticeable financial impact.

Like other financial analysts, Rose already is concerned about the second quarter's high level of expenses, which took Wall Street by surprise, and by the rapid pace of acquisitions Google maintained in the first half of the year. In 2009, Google bought four companies.

In general, financial analysts blamed higher-than-expected operating expenses for Google's pro forma earnings per share of $6.45, which missed the consensus estimate from analysts polled by Thomson Reuters by $0.07.

This caused the company's share price to drop about 4 percent in after-hours trading on Thursday evening and Friday morning. On Monday, Google's stock closed at $466.18 on the Nasdaq exchange, closer to its 52-week low of $423.50 than to its 52-week high of $629.51.

While Morgan Stanley analysts wrote that there is a risk in continuing to invest "at elevated levels" in the future, they also noted that Google's "financial discipline" allowed it to weather the economic downturn last year and that "Google's investments in these [emerging] areas are prudent and may be poised to pay off in the mid- to long-term."

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