Google Q1 Earnings: Ad Revenues Post Growth Once Again

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Google (NASDAQ:GOOG) posted its first quarter 2015 results on April 23rd, reporting 12% year-on-year growth in revenues to $17.7 billion, in line with our expectations. Google’s operating income from continuing operations increased marginally by 3% to $4.40 billion. Operating profit was impacted by increases in R&D and SG&A spending. [1] The markets reacted positively to the results as the stock was up by 3% in the aftermarket trading hours. Pricing pressure on online ads resulted in a 7% year-over-year decline in aggregate cost-per-click (CPC). However, aggregate paid clicks, which represent the number of ads served across Google properties and its member website, grew by 13% year over year. 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 67% to the firm’s value. Online ad spending is expected to increase in general and reach $135 billion in 2015. 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. While the recent trend is indicative of geographical mix, device mix, and property mix, the company has stated that it will continue to monetize mobile devices effectively and the decline has been due to TrueView ads that monetize at lower rates than ad clicks on Google.com. As a result, the aggregate CPC (CPC for both mobile and PC from search and display) declined by 7% year over year during the quarter.

However, Google is looking to monetize its properties through its programmatic platform, which matches relevant ads with content, as well as through 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, the company’s top line growth from search ads has failed to match the growth in search volume. Furthermore, data indicates that over 50% of the web traffic is coming from mobile devices. According to the Interactive Advertising Bureau (IAB), mobile advertising revenues surged by 76% during the first half of 2014, which far outpaced the 15.1% increase in the overall online advertising industry. [2] 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. Going forward, as Google improves its programmatic platform, we expect that the growth in online advertising will grow but continue to weigh on CPC.

Google Play Store for Content

The Google phone division makes up 10% of its estimated value. Considering the growth of Google’s Android platform and the growth in smartphone adoption globally, Google’s Play store is fast becoming a vital cog for Google’s growth in the coming years. Google Play is also connecting developers and content providers with more than 1 billion people on Android devices around the world. Developers are building thriving businesses in this platform, and in February, Google announced that over the past 12 months (FY 2014), it paid more than $7 billion to developers. We expect this figure to grow and  forecast digital content revenue to grow to $8.51 billion (post revenue share of developers) by the end of our forecast period.

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 market. 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 the skippable TrueView ads that are played before YouTube videos are fast gaining traction among advertisers  and grew by 45% in 2014. The company continues to invest in YouTube Partners and Partner revenue has increased by more than 50% year over year. Google’s dominance in the video ad  industry is clear, with nearly 150 million unique viewers as of March 2015, [3] Going forward, YouTube is important for Google even though, according to our estimates, this division constitutes just under 3.4% of its value.

Capital Expenditure Continues to Soar

Google continues to invest heavily in Internet infrastructure and reported $2.9 billion in capital expenditures in the first quarter of 2015. The 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 computing capacity and quality of service. Both these are important as it gives the company a competitive advantage.

We are in the process of updating our model. We currently have a $546 price estimate for Google, which is 5% below the current market price.

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Notes:
  1. 8-K, SEC []
  2. IAB internet advertising revenue report, Interactive Advertising Bureau, October 2014 []
  3. comScore Releases March 2015 U.S. Online Video Rankings, April 22 2015, www.comscore.com []