Google Earnings: Strong Mobile Performance Backed By Programmatic Platform Boosts Revenues

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Google (NASDAQ:GOOG) posted its fourth quarter results on January 29th. The company reported 15% year-on-year growth in revenues to $18.10 billion, which was in line with our expectations as stated in the note published earlier. However, it’s operating income from continuing operations declined marginally to $4.40 billion, primarily due to increase in  investment in research and development and spending on SG&A (Sales, Marketing, General and Administration). [1] The markets reacted a bit positively to the results as the stock was by 1% in the aftermarket trading hours. Pricing pressure on online ads continued to drive a 3% year-over-year decline in cost-per-click (CPC). However, aggregate paid clicks, which represent the number of ads served across Google properties, grew by 14% year-over-year. The revenues also reflected a change in mix as nearly 56% of revenues were from international markets. In this note, we will discuss Google’s results.

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Cost-Per-Click Continues To Decline As Number of Clicks Grow Due to Programmatic Buying

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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.  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 is indicative of geographic mix, device mix, property mix, as well as the ongoing product and policy changes. While international revenue contributes nearly 56% of the total revenues, mobile devices account for a huge influx of queries for Google. [2] 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 3% year-over-year during the quarter.

However, Google is trying to improve its CPC, especially on its mobile devices, by re-inventing its programmatic platform, which matches relevant ads with content, as well as an increase in user-generated online content.  However, this  is negatively impacting Google’s CPC  as the programmatic platform does away with inefficiencies of improper ad matching. 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. According to eMarketer, advertisers’ spending on programmatic platforms will increase to $8.36 billion this year in the U.S. alone. It projects that overall spending in programmatic will increase to $20 billion by 2016. [3]

To cash on this trend, Google is focusing on its programmatic businesses including AdMob, AdExchange, DoubleClick Bid Manager, and these continue to grow at a strong rate. As a result, DoubleClick Bid Manager, its primary frontend for programmatic buying, has doubled in volume over the past year. Furthermore, Google Partner Select, its premium programmatic video marketplace, now has more than 50 publisher partners including Hearst Television, and Food Network, and includes brands like BMW. Going forward, as Google improves its programmatic platform, we expect that the growth in online advertising will grow but continue to weigh on CPC.

Focus on Increasing Internet Penetration

In the last five years, Internet penetration has increased from 1.8 billion or 26.6% of the world population to 2.8 billion or 39%. [4] Furthermore, companies around the world continue to lure more people to the Internet by introducing cheap smart connected devices. Considering the penetration in the mature market, hardware manufacturers are now focusing on emerging countries, which include over 85% of the world population, and contribute almost three quarters of global GDP growth, according to Fidelity Investment Ltd. [5] Google, like many other companies such as Microsoft, etc., is contributing  by launching its cheap Android based platform under the Android One name. [6] Furthermore, PC manufacturing companies like HP are also introducing cheap Windows-based thin tablets and laptops. [7]

Google’s business is heavily dependent on the number of users that use its search engines to query the Internet. The company leverages its popularity across PCs (65% market share) and mobile devices (over 90% market share) to sell ads slots to advertisers. As a result, its PC search ads division makes up 35% of its estimated value, while its mobile search ads division makes up 29% of the value.

Over the past few quarters, Google’s revenues have grown at a slower pace. Much of it can be attributed to the pricing pressure on the cost of ads and a slower growth in search queries across the Internet. During the quarter, and over the past year, Google has expanded its fiber optic  roll-out to new cities. It recently announced that it will roll out fiber optic capability to 18 cities in four metropolitan areas in the U.S. If Google were to succeed with this project, and the number of broadband Internet users were to increase in the next five years, not only would the total addressable market in the U.S. increase, but it can also look into launching these services in other parts of the world where infrastructure hamper Internet penetration. This would boost sale of PCs and smart connected devices across under-served regions would also increase. As a result, we expect growth in the number of queries originating from both PCs and mobile devices.

Youtube Boosts Ad Volumes

In our pre-earnings note, we mentioned that we would be closely watching YouTube because it caters to the rapidly growing online video ad space. During the earnings call we got some encouraging metrics from management, which makes us confident about YouTube as an essential driver of revenue growth going forward.  Management stated that YouTube now has more than 1 billion users, and watch time is up 50% year-over-year. The company continues to invest in YouTube Partners and Partner revenue has increased by more than 50% year-over-year. Furthermore, mobile revenue on YouTube is up more than 100% year-over-year. To ensure that YouTube’s dominance continues across mobile devices, the company announced new ad formats customized for mobile screens, and expanded YouTube’s TrueView ads into AdMob’s network of more than 650,000 mobile apps. Considering Google’s dominance in the video ads industry, with nearly 162 million unique viewers as of November 2014, [8] we expect it to do well in the mobile video space too.

Furthermore, Google launched YouTube music key beta, a monthly music subscription service that provides ad free music, background play, and offline viewing. This will also include a subscription to Google Play Music with more than 30 million songs, expert queue rated play lists, and more. This adds another revenue stream to YouTube. Going forward, YouTube is important for Google because, according to our estimates, this division constitutes just under 10% of its value. Revenues from this division were around $3.7 billion in 2013, and we think that they will continue to grow and reach around $18 billion by the end of our forecast period.

Capital Expenditure Continues to Soar

Google continues to invest heavily in Internet infrastructure and reported $3.3 billion in capital expenditures in the fourth 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 are in the process of updating our model. We currently have a $546.89 price estimate for Google, which is 8% above the current market price.

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Notes:
  1. 8-K, SEC []
  2. Earnings Transcript Q4 []
  3. 7 Advertising Trends That Show You Exactly Where This Industry Is Headed Mobile and programmatic are changing everything, October 16 2014, www.adweek.com []
  4. Internet Growth Statistics []
  5. Emerging markets insight []
  6. Read more about this here []
  7. Read more about this here []
  8. comScore Releases November 2014 U.S. Online Video Rankings, December 18 2014, www.comscore.com []