Alphabet Earnings Preview: Revenues To Grow On The Back Of Increasing Video And Search Ads Google

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Alphabet (NASDAQ:GOOG) is set to release Google’s Q3 2016 earnings on Thursday, October 27th. [1] In Q2, the company reported that its revenues grew by over 21% year over year to $21.50 billion. However, cost-per-click (CPC), which has been declining for the past three years, continued to negatively impact growth. This decline was offset to some extent by the growth in aggregate clicks as Google’s search products continue to find favor with advertisers. Additionally, the company continues to witness robust adoption of its enhanced campaigns program that combines ad marketing campaigns across mobile devices, desktops and laptops—i.e., across screens with different form factors. The program was instrumental in generating ad volume growth across the display and search ad divisions.

Google continues to focus on improving its display revenues from YouTube. Additionally, Google continues to sell more of the ads inventory through its programmatic platform, which is driving aggregate paid clicks and revenues across desktop and mobile verticals. However, the company continues to burn cash for its ‘other bets’ as the search for next multi-billion dollar money maker continues.

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Revenues To Increase Despite Decline In Cost per Click

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We currently estimate that PC search ads and Mobile search ads respectively contribute approximately 18% and 22.5% to the firm’s value. The company, with a 63% market share, dominates the PC search engine market. 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 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, most of the web traffic is coming from mobile devices, which have lower revenue per search than desktop. As a result, as advertisers realign their ad budgets in favor of mobile devices, chances are that the blended revenue per search (RPS), an average of desktop and mobile RPS, will suffer. Therefore, we believe the downtrend in RPS (a derivative of CPC) continued in Q3, and expect the company to report lower RPS, accordingly.

Even though CPC will decline due to advent of mobile usage, the company continues to rely on its programmatic platform to adequately match the inventory with advertisers. This has helped the company to report growth in its revenues. We expect this trend continued in Q3 and that ad revenues will grow in absolute numbers buoyed by growth in search volume across mobile and desktop due to growth in inventory sold through programmatic platform.

Android’s Dominant Position To Help With Revenue Growth

Alphabet’s 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 deep penetration in the smartphone market. A user with an Android phone is more likely to use Google search compared to a user using another OS. Considering the widespread use of Android based smartphones, we expect revenues from mobile ads will have grown at a robust pace in the Q3 of 2016. Furthermore, as the multi-platform enhanced campaigns program continues to evolve and Google continues to roll out more of its ads on its programmatic platform, we expect the aggregate paid clicks to increase and boost the number of ads sold.

Video Ads To Boost Revenues From YouTube

According to our estimates, YouTube contributes approximately 16.4% to Alphabet’s value. YouTube has found a niche for itself in the $64 billion video-on-demand (VoD) industry [2] and is disrupting the the $200 billion TV advertising industry.  According to comScore, Google’s sites are also ranked as one of the top video ads web properties in the U.S., reaching 36.1% of the audience. YouTube is forecast to record 3.5 trillion video views during 2016. Since online video remains a fast growing segment within the overall digital ad market, we expect this to translate into high-revenue growth rate for the company. We expect that the unique user count for YouTube rose during the quarter, given the increasing popularity of this platform.

Other bets Will Continue To Report Losses

Alphabet continues to burn through cash in order to search for the next disruptive product in different industries such as the life sciences and IoT. While we expect that the company will continue to report losses for its other bets, the revenue for these division will be higher during the quarter.

We currently have a $773 price estimate for Alphabet, which is inline with its current market price.

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Notes:
  1. Alphabet Announces Date of Third Quarter 2016 Financial Results Conference Call, September 15 2016 []
  2. OTT TV & for Q2’16ideo Revenues To Generate $65 Billion, July 19 2106 []