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Google's Search Business Runs On 75% Profit Margin

Just when you thought it was safe to go back into the ocean, someone reminds us just how deadly the shark out there really is. In this case the Great White in question, Google, is even more profitable than many of us had dared to consider.
Just when you thought it was safe to go back into the ocean, someone reminds us just how deadly the shark out there really is. In this case the Great White in question, Google, is even more profitable than many of us had dared to consider.Henry Blodget dissects Google's latest quarterly report. Here is the first cut:


Google booked free cash flow of $1.1 billion in Q3, more than any other media company we know of. The company also improved its operating margin (on net revenue) to 50%. In other words, it's a fantastically profitable $16 billion global business that is still growing at better than 50% per year.

But guess what? "Fantastically profitable" doesn't even begin to describe the earnings power of Google's core business. For example, this is not a business that has mere 50% profit margins -- a level that just about every other company on earth would kill for. Rather, this is a business that probably has better than 75%+ operating margins -- a level that only one of Google's fellow behemoths, Microsoft, could ever hope to match.

Google's core business is running on 75% (or more) operating margins? This goes beyond even my own wildest estimates. No wonder Google is spending on startups like there's no tomorrow. The company is throwing off cash like a broken ATM. Google can absorb insane amounts of cost:


How do we know Google's core search and AdSense businesses have better than 75%+ profit margins? Because, for the last four quarters, Google's rate of hiring (people) has significantly outpaced revenue growth. Salespeople and engineers take 6 months to a year to get fully productive, so most of the 6,000 employees Google has added in the past year aren't yet fully utilized...

Given the number of products Google has rolled out, moreover, only a fraction of these folks (except sales) are likely dedicated to search and AdSense. Google isn't yet generating meaningful revenue from any products other than search/AdSense, so this means that these folks are dead weight on the P&L. But Google still has a profit margin of 50%.

This isn't the scariest part, either. It looks like Google's hiring spree is finally slowing down:


At some point, the company will finally scale back hiring (from Schmidt's comments on the call, it sounds like this has just happened). As it does, expense growth will slow, while revenue productivity from existing employees will grow. Unless the company rapidly ramps spending on other nonrevenue generating projects, therefore, Google's profit margin could leap upwards in the coming year.

Blodget claims that Google has loads of penned-up revenue generating potential, both in terms of the number of technologies and engineers it has acquired or hires and the sheer number of freshly minted sales people who aren't yet clicking on all cylinders.

If you add all this up, Google could be about to open up a new can on the Web, with even greater profitability and revenue growth. I took Blodget to task a few weeks ago for predicting Google at $2,000 a share. I may have to rethink that blog post now.