Google (NASDAQ:GOOG) reported earnings for Q4 on January 22. The company’s stock rose 5% after market as the company reported consolidated revenues of $14.4 billion, up approximately 36% year-over-year. However, Google’s core revenues (revenues ex-Motorola) only grew to $13 billion, growth of 21% year-over-year. While the company reported strong top-line figures, its operating income fell by approximately 5% to $3.5 billion. It also reported higher traffic acquisition costs as a percentage of advertising revenues: 25% in Q4 2012 versus 24% in 2011. 
While mobile advertising has driven a steep decline in cost-per-click (CPC) in the past (it declined 15% in Q3) the trend slowed in Q4 as CPC only declined by 6%. Aggregate paid clicks also posted solid growth increasing 24% y-o-y and 9% quarter-over-quarter. This led to a 20% increase in advertising revenues.
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Motorola Continues to Be A Drag on Operating Income
The year-over-year decline that Google reported in operating income was due to the Motorola division, which reported an operating loss of $353 million and was less than the $527 loss it posted in Q3. Google’s core operating income actually increased to $3.75 billion, which generated a core operating margin of 29%.
With the inclusion of the Motorola division on Google’s financials, hardware has become a significant portion of the firm’s revenues. While the division is and will continue to be a drag on Google’s margins, we think that synergies between Android and Motorola’s smartphone/tablet business will make the Google – Motorola combination an interesting player to watch in the hardware industry.
Focus Again on Mobile
Mobile was again the focus during the company’s earnings call since it will be the key to Google’s business going forward. We currently estimate that Mobile search ads contribute approximately 35% to the firm’s value, primarily because we expect mobile advertising revenues to increase. Even though mobile search ads are expected to only generate 13% of the company’s total revenues in 2013, we expect the proportion to increase to 25% by 2016.
Since the average revenue per search is lower for mobile ads, the rise in mobile advertising will continue to weigh on average cost-per-click charged to advertisers in the coming quarters. However, we think that the strength of the Android platform will increase continue to increase the number of aggregate paid clicks which should offset the decline in CPC going forward.
Youtube growth provide diversification
In our pre-earnings article we mentioned that we would be closely watching Youtube because it offers much needed diversification to Google’s business. During the earnings call we got some encouraging metrics from management which give us confidence that Youtube will be a bigger driver of revenue growth going forward. Management stated that viewers watched more than 4 billion hours of video per month on Youtube in 2012. On the monetization front, top advertisers on Youtube spent 50% more than what they spent in 2011.
We think that Youtube is important because according to our estimates, the division constitutes approximately 8% of Google’s value. Revenues from this division were around $1.5 billion in 2011, and we think that they will continue to increase and hit around $15 billion by the end of our forecast period.
We currently have a $691 price estimate for Google, which is approximately 7% below the current market price. Google derives most of its value from advertising, a space where it competes primarily with Microsoft (NASDAQ:MSFT), Yahoo (NASDAQ:YHOO) and Facebook (NASDAQ:FB).Notes: