Google Declines After Biggest Increase in Costs Since 2008

April 15 (Bloomberg) -- Google Inc. shares fell the most since December 2008 after a first-quarter hiring binge and increased marketing led to the biggest jump in operating expenses in three years.

First-quarter operating costs rose 54 percent, outstripping a sales gain of 29 percent to $6.54 billion, the Mountain View, California-based company said yesterday. Profit excluding some items was $8.08 a share, below the average analyst estimate of $8.12 compiled by Bloomberg.

Larry Page, who replaced Eric Schmidt as chief executive officer last week, is ramping up spending to pursue new growth opportunities, including mobile and video advertising. Google boosted hiring by more than 1,900 people during the quarter, part of a plan to add at least 6,000 this year. At the same time, he’s grappling with growing regulatory scrutiny of the company’s market-leading Internet-search business.

“The concern is that the expense discipline may be leaving as Eric Schmidt steps away,” said Clayton Moran, a Boca Raton, Florida-based analyst at Benchmark Co., who recommends buying the stock and doesn’t own it. “The company through the recession had shown significant financial discipline.”

Google declined $47.81, or 8.3 percent, to $530.70 at 4 p.m. New York time in Nasdaq Stock Market trading. The shares have dropped 11 percent this year.

Sales Growth

The $6.54 billion in sales -- a figure that excludes revenue passed on to partner sites -- topped the $6.32 billion average of estimates. First-quarter net income climbed 18 percent to $2.3 billion, or $7.04 a share, from $1.96 billion, or $6.06, a year earlier.

“The investors we have actually understand that we are building businesses for the long term,” Patrick Pichette, chief financial officer, said in an interview yesterday. “They also want growth, which we delivered this quarter.”

Google, while demanding financial accountability internally, continues to invest in areas such as marketing of the Chrome Web browser, Pichette said during a conference call with analysts. The earthquake and tsunami in Japan, meanwhile, crimped ad sales during the quarter. That impact will carry over into the latest period, he said.

The current investments will help fuel future revenue growth, even if they push up costs in the short term, said Larry Haverty, a portfolio manager at Gamco Investors Inc. with more than 60,000 shares of Google.

Making It Work

“They have tremendous technology,” Haverty said during a televised interview with “Bloomberg West.” “I’m confident having watched this thing for 37 quarters that these guys one way or the other are smart enough to turn incremental revenue into profit.”

The company is relying on its Android operating system and last year’s acquisition of AdMob Inc. to tackle the mobile market, putting it in closer competition with Apple Inc. There are now about 350,000 Android devices being activated a day, up from about 300,000 a day in January, Jeff Huber, senior vice president of engineering, said during the call.

Google also is increasingly squaring off against Facebook Inc. in social features and display advertising -- the banners and videos that appear on websites. Google introduced a social- networking service last month that lets users point out search results to friends.

The company had 26,316 employees at the end of the first quarter, up 7.9 percent in December. Research and development costs rose 50 percent from a year earlier, while sales and marketing climbed 69 percent.

Regulatory Challenges

Schmidt, who became executive chairman when Page stepped into the CEO role, is now focusing on external affairs and government relations.

Google faces deepening challenges on the regulatory front. The U.S. Federal Trade Commission is weighing a broad antitrust probe, people familiar with the matter said this month. And the European Commission and Texas Attorney General Greg Abbott have begun investigations into whether Google is skewing its search results to favor its own businesses over competitors’ websites.

The heavier scrutiny should be expected as Google gets larger, Pichette said. Regulators have a job to do and the company works closely with government agencies, he said.

In his first week on the job, Page promoted seven of his managers to senior positions, including Andy Rubin, who heads up mobile efforts, and Vic Gundotra, who is in charge of social initiatives, according to a person briefed on the changes. The executives will report directly to Page, the person said.

Keeping Pace

Page’s changes are designed to streamline engineering and product development, placing a single manager in charge of each product group, said Chris Gaither, a company spokesman. Page, 38, said in January that the company needs to maintain its pace as Google becomes larger.

The rising costs show Page is focused on long-term results, even if investors aren’t happy about it, said Sameet Sinha, an analyst with B. Riley & Co. in San Francisco. He recommends buying the stock, which he doesn’t own.

“He’s saying, ‘I’m not afraid of spending,’” he said. “I know it will impact my stock, but I’m more of a product guy and a technologist, and I care more about creating technology and putting it out there. And if it means taking a short-term hit, so be it.”

--With assistance from Doug MacMillan and Emily Chang in San Francisco. Editors: Nick Turner, Stephen West
To contact the reporter on this story: Brian Womack in San Francisco at bwomack1@bloomberg.net
To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net