Google Earnings Preview: Cost-Per-Click, Mobile And Video Ad Revenues In Focus

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Google (NASDAQ:GOOG) is set to release its Q3 2014 earnings on Thursday, October 16. In Q2, the company reported that its revenues grew by over 22% year over year. However, the result failed to enthuse investors who were expecting far better growth in both the top line and the bottom line. Cost per click (CPC), which has been declining for the past two years, continued to negatively impact growth. However, this decline was offset to some extent by the adoption of its enhanced campaigns program that combines marketing campaigns across mobile desktop and laptops, i.e. across screens of different sizes. This program was instrumental in ad volume growth across the display and search ad divisions. In this earnings announcement, we expect the enhanced campaigns program to once again drive revenue growth across its mobile and PC search ad divisions. Furthermore, as YouTube continues to gain popularity, we expect display ad revenues to be higher.

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Cost per Click To Effect Revenue Growth

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We currently estimate that PC search ads contribute approximately 35% to the firm’s value. The company, with a 65% market share, dominates the PC search engine market. The cost per click (CPC), a metrics 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. As a result, company’s top line growth from search ads has failed to capitalize on the growth in search volume. Furthermore, the recent trend indicates that over 50% of the web traffic is coming from mobile devices. As advertisers realign their ad budgets in favor of mobile devices, chances are that desktop revenue per search (RPS) will suffer. Therefore, we expect the downtrend in RPS (also known as CPC) to continue in Q3, and the company to report lower RPS. Currently, we project RPS to decline from $23 to $22 by 2020. However, we expect ad revenues to grow in absolute numbers, buoyed by growth in search volume.

Revenues From Mobile Ads To Grow

The mobile search ads division is the second largest division for Google and makes up approximately 29% of its total value, according to our model. Google, with 90% market share, dominates the mobile search engine market. One of the key reasons for this dominance is its flagship Android OS, which has witnessed excellent adoption and penetration in the smartphone space. A user with an Android phone is more likely to use Google search compared to a user using another OS. This is especially relevant when competing with OS’s such as Apple and Windows Phone use their own search engines on the mobile devices. To ensure Android’s dominance, Google has partnered with smartphone manufacturers in emerging markets to launch inexpensive phones, which should help the company to capture bigger market share in the emerging countries. We expect Android to have a market share of over 80% in the smartphone industry by the end of 2014, and revenues from mobile ads to grow at a robust pace in the Q3 of 2014. Furthermore, as the multi-platform enhanced campaigns program continues to evolve and adoption rate goes up, we expect the aggregate paid clicks to increase and  boost the number of ads sold in Q3.

Video Ads To Boost Revenues From YouTube

According to our estimates, YouTube contributes approximately 8% to Google’s value. According to comScore, Google is the market leader in the online video content industry. The primary reason for Google’s dominance in the video ads industry is its reach among users with nearly 159 million unique viewers as of August 2014. [1] According to comScore, Google sites are also ranked as the top video ads web property in the U.S., reaching 37% of the audience. To ensure that YouTube  improves upon the quality of content available to users, Google is funding content creation from some of its top creators. We believe that this will positively impact unique user count in the long run. [2] Nevertheless, we expect that the unique user count for YouTube rose during the quarter, given the increasing popularity of this platform. Furthermore, as the explosive growth in online video ads spending continues, YouTube will be able to leverage its popularity to buoy Google’s revenue going forward.

We currently have a $547 price estimate for Google, which is 3% below its current market price.

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Notes:
  1. comScore Releases August 2014 U.S. Online Video Rankings, September 18 2014, www.comscore.com []
  2. Investing in creativity, September 18th 2014, YouTube Blog []