Google (NASDAQ:GOOG) posted its first quarter results on April 16. The company reported 19% year-on-year growth in revenues to $15.42 billion, which were in line with our expectations. Its operating income from continuing operations grew by approximately 3.5% to $3.65 billion. However, the profits failed to enthuse the market which was expecting far better results. The company also reported lower traffic acquisition costs in absolute numbers and as a percentage of advertising revenues: 23.3% in Q1 2014 versus 25.0% in 2013.  Growth in revenues from mobile advertising drove a steep 9% year-over-year decline in cost-per-click (CPC). However, aggregate paid clicks, which represent the number of ads served across Google properties, posted a solid 26% year-over-year growth. This led to a 17% increase in advertising revenues during the quarter.
Cost Per Click Falls As Ads On Mobile Increases
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We currently estimate that PC search ads and mobile search ads contribute approximately 65% to the firm’s value. Online ad spending is expected to increase in general. eMarketer has predicted that worldwide mobile ad spending will exceed $31.45 billion in 2014.  Even though mobile search ads are expected to only generate 17% of the company’s total revenues in 2014, we expect the proportion to increase to over 35% by 2020.
The cost per click (CPC), a metric that measures the price paid for the number of times a visitor clicks on a search ad, has been on a steady decline for the past few years. The recent trend indicates that over 50% of the web traffic is coming from mobile devices. Advertisers have realigned their ad budgets in favor of mobile devices. Traditionally, CPC for mobile ads is lower compared to that of a PC. As a result, the average blended CPC (CPC for both mobile and PC) declined by 9% year over year during the quarter. However, CPC was flat sequentially, since the company has successfully launched enhanced campaign that bundles mobile ads with desktop ads, and eliminates the difference between PC CPC and mobile CPC. Going forward, we expect that the growth in mobile advertising will continue to weigh on CPC.
Capitalizing On The Popularity Of Android With Play Store
Google’s phone division makes up 8% of its value. Google continues to leverage the growing popularity of its Android operating system with app sales on its Play store. Furthermore, Google’s apps (such as Google Play, Search and the YouTube app) have close to 50% reach for the mobile audience according to comScore.  This was reflected in the growth of Google’s other revenues, which grew by 48% year over year to $1.55 billion, and is primarily composed of revenues from sale of digital content. Going ahead, we expect revenues from digital content to grow to $5.6 billion by 2020, bolstered by the increasing use of Internet to deliver content such as movies, books and music.
Capital Expenditure Continues To Soar
Google continues to invest heavily in Internet infrastructure and reported $2.3 billion in capital expenditures in the first quarter of 2014. Majority of capital investments are for IT infrastructure, including data center construction, servers and networking equipment. Google has been steadily ramping up its spending for the past couple of years, in an effort to improve its return on investment and quality of service. We expect capex spending to continue at these levels in the coming quarters, which will lower cash flows.
We currently have a $544 price estimate for Google, which is in line with the current market price.Notes:
- 8-K, SEC [↩]
- Driven by Facebook and Google, Mobile Ad Market Soars 105% in 2013, March 19 2014, www.emarketer.com [↩]
- comScore Reports January 2014 U.S. Smartphone Subscriber Market Share, March 7 2014, www.comscore.com [↩]