Google gets frugal and profits soar

October 17, 2008, 12:24 AM UTC

By Yi-Wyn Yen

Meet Google 2.0. Gone are the search giant’s free-spending ways – at least for now. The prospect of a severe economic slowdown has forced Google to do something surprising: act fiscally responsible.

The company toned down costly expenses like data centers and new hires and reported profits Thursday of $1.35 billion for the third quarter, up 26% from a year ago. Earnings per share were $4.92, which crushed Street estimates of $4.75 a share.

Google (GOOG) shares rose nearly 11% in after-hours trading to $390. “This is very encouraging to hear that they’re reining in costs and not acting like the drunken sailors that they once were,” said Jefferies analyst Youssef Squali.

The company reported sales of $4.04 billion, a 34% spike from the year-ago quarter, and in line with the Street’s estimates of $4.05 billion.

CEO Eric Schmidt reassured investors that Google’s disciplined outlook would help the company weather an economic downturn. “There’s an awful lot of stuff going on in the world,” he said during an hour-long call with analysts Thursday. “We have a duty and responsibility to run Google well.”

The company scaled back spending on its biggest costs in the third quarter. The company’s capital expenditure for servers and networking equipment was $452 million, its lowest since the first quarter of 2006.

Google also has been trimming general and administrative costs. For the quarter, the company’s expenses grew 28% to $412 million from the same period a year ago. Google, which drew criticism last year for growing too quickly, added 519 employees for the quarter. Last year, the company averaged 1,500 new hires each quarter. “We’ll continue to hire in many areas, but we will do it responsibly,” said Patrick Pichette, Google’s new CFO.

Though many analysts and investors fear that advertisers will sharply scale back on online advertising for the current quarter, Google executives argue that the company could potentially benefit from a recession. Unlike Yahoo (YHOO), which relies heavily on banner-based advertising, Google makes 97% of its revenues from search-based advertising. Google’s chief economist Hal Varian noted that when consumers are “counting their pennies,” they’ll spend more time researching online. More bargain-hunting users will lead to more advertisers, thus creating a “Wal-Mart effect,” according to Varian.

Analysts say they are optimistic about Google’s growth during an uncertain economy. The number of clicks for Google’s paid search ads on third-party sites rose 18% in the third quarter from the same period a year ago. Said Squali: “They don’t seem to be experiencing the weakness you see with a lot of other online players.”

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