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Google: Morgan Stanley Turns Bullish; Sees 20% Upside

71080438Google shares are getting a lift Monday morning from Morgan Stanley analyst Scott Devitt, who this morning lifted his rating on the stock to Overweight from Equal Weight, setting a price target of $775 – about 20% above Friday's close at $642.

"At 13X consensus 2013 EPS, Google trades at a 25% discount to the online advertising sector despite similar earnings growth and fewer execution risks," he writes in a research note. "Fears may recede, and multiple expand, in coming quarters: Google's core business has delivered impressively stable currency-neutral [year-over-year] revenue growth averaging 25% in each of the past 9 quarters, yet Google's stock has experienced multiple compression due to fears of social network competition, mobile-related revenue erosion, and [Motorola Mobility] distraction. We believe shares can re-rate as investors discover that social competition is less than feared, mobile revenue contributions have been mostly incremental, and Google may bring more discipline to MMI than widely assumed."

Over the weekend, Google disclosed plans to cut 4,000 jobs at the newly acquired Motorola Mobility unit.

Devitt likes the fact that management seems to be "becoming somewhat more communicative," detailing key strategic growth areas, and canceling underperforming projects.

Meanwhile, the analyst sees Google's U.S. and U.K. operations growing 11% compounded through 2016, with the rest of the world growth 18%. For the same span, he sees search revenue growing 14% on an annual basis compounded, video 15% and display 17%. Devitt, who previously had estimates below the Street consensus, moves more in line, and now sees profits of $47.43 a share in 2013, $56.32 in in 2014 and $64.87 in 2015.

One key element of Devitt's report is his contention that investors have become more concerned that necessary about the competition from Facebook.

"A concern that we believe may have tempered enthusiasm to own Google shares over the past several quarters is the rise of social networks, and fear that they may begin to take share from established forms of online advertising, such as search engines," he writes. "We view this concern as taking two forms: (1) social networks replacing search as a discovery mechanism, and (2) social networks launching products that are more appealing to advertisers."

But he sees "little evidence of either happening."

On the one hand, he writes that "social networks have indeed captured an increasing amount of time spent on the Internet," but that portals rather than search engines are feeling the resultant pain. "Indeed, time  spent with search engines continues to grow at the overall rate of Internet expansion, and search engines reach more users globally than social networks. In our view, social networks serve a different purpose than, and therefore do not appear to have displaced, the utility that search engines provide."

As for the advertising concerns, Devitt asserts that "currently-available social network advertising products, such as side-rail display ads and sponsored stories, do not appear to have dissuaded advertisers from increasing search campaigns on Google." He thinks there's a good chance at least one social networking firm could launch an ad network in the "near- to medium-term." While the market sees a threat, he thinks that such a new entrant will have little impact on Google's financial results.

"Of the $10 billion [in] revenue that Google generated in 2011 through its advertising network of third-party sites, we believe that roughly half was related to Google powering other search engines and around half to non-search contextual advertisements, or about $5 billion," he writes. "Given Google's reach into more than 75% of the top 1 million global websites, we assume that Google may capture around three-quarters of worldwide ex-China contextual advertising revenue. If a social networking firm decides to launch a third-party ad network near the end of 2012, we see the potential for it to capture around $2.5 billion in gross network revenue by 2015, achieving around 20% market share. Under such a scenario, Google's share may shrink to around two-thirds."

He estimates that a competitor capturing $2.5 billion of Google's gross network revenue would cut Google's net ad revenue by about $750 million."This would represent just 1% of Google's net advertising revenue of around $54 billion in 2015," he writes. "We therefore perceive the threat of a social network launching an advertising network of this size as not material to Google's overall net revenue or profit."

GOOG this morning is up $7.16, or 1.1%, to $649.16.

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