Google Earnings: Increase In Ad Volumes Buoys Results

Google (NASDAQ:GOOG) posted its third quarter results on October 17. The results were better than expected and the stock rose 8% in after-hours trading on the day to $960. The company reported 12% year-over-year increase in consolidated revenues to $14.89 billion. Google’s core revenues (revenues ex-Motorola) grew by 19% to $13.77 billion. The highlight of this earnings announcement was the 25% y-o-y increase in GAAP operating income as the company was able to sell more ads during the quarter. We believe that much of the improvement in ads volume can be attributed to the enhanced campaigns launched by the company in the first half of the third quarter. However, the cost per click declined once more as advertisers increasingly routed their budget spend towards mobile devices from PCs.

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Enhanced Campaigns Fillip Mobile Ads

One of the pressure points for Google has been to bolster its online ads revenues, which seem to be slowing down. To tackle this issue, the company launched the enhanced campaigns program at the start of Q3. This new program automatically bundles desktop, tablet and cellphone ads for all campaigns. According to Google, this program simplifies the process for advertisers and makes it easier to reach customers who use multiple devices with different screen sizes. In our earnings note for Q2, we had argued that if this program were successful, it can bolster Google’s revenues. Additionally, in our note published earlier, we had argued that mobile is the key to Google’s revenue growth over the long term.

Considering that advertisers are increasingly advertising on mobile devices, bundling of ad campaigns was a good move by Google. As this program came into effect, it was instrumental in increasing the aggregate paid clicks, which mirrors the number of ads sold by 26% during the quarter. This program stimulated the demand for mobile adwords as advertisers were bidding more frequently for them. ^[1] We expect this trend to continue as more advertisers switch to enhanced campaigns in the future. Additionally, we think that the Android platform, which now runs on over a billion devices, will continue to lead as the preferred mobile device platform, and this will increase the number of aggregate paid clicks, which can offset the decline in cost per click (CPC) to some extent going forward.

Cost per Click Falls as Ads On Mobile Increases

We currently estimate that mobile search ads contribute approximately 32% to the firm’s value. Gartner has predicted that worldwide mobile ad revenue will exceed $11 billion in 2013, and that the growth rate for ad revenue will exceed 400% during 2011-2016. ^[2] Even though mobile search ads are expected to only generate 17% of the company’s total revenues in 2013, we expect the proportion to increase to over 35% by 2020.

Traditionally, CPC for mobile ads is lower compared to that of a PC. As advertisers increased their spent on mobile devices, average CPC for Google declined by 8% in Q3 2013. ^[3] Since the average revenue per search is lower for mobile ads, the growth in mobile advertising will continue to weigh on average CPC charged to advertisers in the coming quarters. However, by launching the enhanced campaigns, Google is trying to eliminate the difference between PC CPC and mobile CPC. We believe that this program can arrest the decline in CPC in the future.

Robust Growth At YouTube

In our pre-earnings note, we mentioned that we would be closely watching YouTube because it caters to the rapidly growing online video ads space. During the earnings call we got some encouraging metrics from the management, which makes us confident about YouTube as an essential driver of revenue growth going forward. The management stated that brand advertising on YouTube is growing at a robust pace of 75% y-o-y. We think that YouTube is important because according to our estimates, this division constitutes just under 10% of Google’s value. Revenues from this division were around $2.7 billion in 2012, and we think that they will continue to grow and reach around $18 billion by the end of our forecast period.

Motorola Continues To Dent Operating Income

In our pre-earnings note, we mentioned that we would be closely watching the Motorola division because it continues to post operational loss since its acquisition last year. Motorola posted another quarter of disappointing results as the GAAP operating loss of the division increased to $248 million.

With the inclusion of the Motorola division on Google’s financials, hardware has become a significant portion of the firm’s revenues. While we believe that this division will continue to be a drag on Google’s margins, we think that synergies between Android and Motorola’s smartphone/tablet business will make the Google – Motorola combination an interesting player to watch for in the hardware industry. Motorola recently launched of Moto-X smartphone. While it is still early to comment on the sales of Moto-X as the company has not disclosed any information, we intend to closely observe the Moto-X sales figures in the coming months.

We are currently in the process of updating our Google model. At present, we have a $865 price estimate for Google.

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1. Earnings Transcript, October 17 2013, www.seekingalpha.com [↩]
2. Gartner Worldwide Mobile Advertising Revenue, January 17 2013, www.gartner.com [↩]
3. Statistics on mobile usage and adoption to inform your mobile marketing strategy, June 10 2013, www.smartinsights.com [↩]