Google Inc Coverage Initiated With 'Equal-Weight': Morgan Stanley

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Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) deals with the law of large numbers, and Wall Street may have set its expectations too high, according to Morgan Stanley analysts. As a result, they have initiated coverage of the search giant with an Equal-weight rating and $600 per share price target.

Wall Street estimates too high?

In their report dated Nov. 3, 2014, analysts Benjamin Swinburne and Hersh Khadilkar and their team said their estimates for Google are meaningfully lower than consensus estimates. They note that the company’s third quarter earnings results demonstrated that search growth is slowing down in the U.S. and the U.K., which are two of the most mature markets.

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In spite of slowing search growth, the Morgan Stanley team said they think Wall Street’s estimates for next year’s revenue look “aggressive,” especially when taking into account headwinds from currency exchange rates.

Google is a long term winner

They point out that search already makes up 14% of all ad spend in the U.S., passing all of cable TV. In addition, they say Google is going head to head with Facebook Inc (NASDAQ:FB), a competitor that’s becoming “increasingly formidable” in the digital ad space.

Additionally, they say that growth in mobile search isn’t sustaining the historical overall search growth rates. They suggest that this may be because the mobile app environment is now better organized.

In the long term, the Morgan Stanley team likes Google, but they think a lower share price is needed before they would get into the stock.

Google’s margins under pressure

The analysts also point out how much Google plans to spend in capital expenditures, research and development, and stock compensation. In 2012, the search giant spent $11 billion, but this year, that number has jumped to $22 billion. It means that two years ago, Google spent 29% of its net revenue on these categories, but this year, the company is spending 42% of its net revenue.

They add that these investments will probably pay off eventually, but they don’t think the returns will go up to the level of Google’s core search business. As a result, the company’s margins could be pressured “for some time.” They point out that Google’s EBITDA margins have fallen by about 900 basis points from their peak in 2009.

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