Google Earnings Preview: Ad Volume Growth To Offset Decline In CPC

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Google (NASDAQ:GOOG) is set to release its Q4 2014 earnings on Thursday, January 29th. In Q3, the company reported that its revenues grew by over 20% year over year to $16.52 billion. 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 ad marketing campaigns across mobile, desktop and laptops, i.e. across screens with different form factors. This program was instrumental in generating 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 32% 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. The primary reason for this has been both the advent of programmatic buying that matches relevant ads with content, as well as an increase in user-generated online content. As a result, company’s top line growth from search ads has failed to match the growth in search volume. Furthermore, data indicate 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 Q4, and the company to report lower RPS. Currently, we project RPS to decline from $23 to $22 by 2021. 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 32% 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. Competing OS’s such as Apple’s iPhone and the 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 based on its Android One platform, which should help the company to capture bigger market share in the emerging countries. We believe that Android’s market share was over 80% in the smartphone industry at the end of 2014.  Moreover we expect revenues from mobile ads will have grown at a robust pace in the Q4 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 Q4.

Video Ads To Boost Revenues From YouTube

According to our estimates, YouTube contributes approximately 9% 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 162 million unique viewers as of November 2014. [1] According to comScore, Google sites are also ranked as one of the top video ads web properties in the U.S., reaching 33.6% of the audience. 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 8% above its current market price.

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Notes:
  1. comScore Releases November 2014 U.S. Online Video Rankings, December 18 2014, www.comscore.com []