Saturday, November 10, 2007

Is Google A Bank?

Google (GOOG) in their Ad Sense segment and other areas may be acquiring the negative bank settlement risk of foreign exchange trading that most international banks have long learned to manage. Consider this.

Google currently reports international earnings and expenses separately. This allows investors to track non US growth. Supposedly over time individual international segments will be broken out in greater detail as they achieve greater importance. The current accounting presentation is similar to old school manufacturers who expand into foreign countries and report according to political and currency boundaries. But Google is not an old school manufacturer.

Google AdSense pays it's partner sites in a variety of foreign currencies. The conversion rate into the partner's account is determined at the date the cheque is cut or the date of wire transfer. Typically this is at the end of the month.

Google is paid by its advertisers in a variety of currencies. Small accounts pay up front and then are charged as clicks occur. Bigger accounts put up a credit card and pay accordingly. Really big customers are most likely billed. Any way you cut it the click may be earned in one currency but paid in another. There is also the complication that certain clients do not need to settle in a cash on the barrel manner. You therefore have a time element where Google accepts naked unhedged FX risk.

This results in an inherent float. Many of the payments are micro in size and difficult to predict precisely. Once they occur the foreign exchange factor is an historical fact with either a positive or negative impact that is set in concrete. At least with banks they have scheduled payments and flows which have predictability and therefore the foreign exchange trader has the ability to model.

Google in its Q3 earnings stated "Had foreign exchange rates remained constant from the second quarter of 2007 through the third quarter of 2007, our revenues in the
third quarter of 2007 would have been $24 million lower. Had foreign exchange rates remained constant from the third quarter of 2006 through the third quarter of 2007, our revenues in the third quarter of 2007 would have been $121 million lower."

This means that currently as the US dollar tanks Google is a net winner in the above scenario. Currencies however fluctuate. Investors focused on a US$ EPS may become very disappointed if the FX rate moves the wrong way.

The whole issue is that click activity will not stay in a currency silo. I personally do not care who clicks on an Ad on this blog. As long as I get paid, which I do, on time. At the same time I do not know what currencies are used to settle payments with the Ad's on this site. As the world increasingly globalizes and activity jumps from one currency silo to another how does Google manage FX risk one click at a time.

In the last quarters results Google reported revenues of US$ 4.23 Billion. Assuming a 90 day quarter and 24 hous per day: Google revenues are US$ 1.96 million per hour. But in what currency? Revenue growth rates are huge and are unsuited to reliable modelling.

So please do not say just hedge it. The investment world is very suspicious of supposed hedge strategies. There is a lot of pain out there that should not exist if the hedge salesman had been corrrect.

Comments are most welcome.