Alphabet Earnings Preview: Search And Video Ads Revenues Set To Grow, Moonshot Venture Will Continue To Hemorrhage Profitability

Alphabet Inc. (NASDAQ: GOOG, GOOGL) is set to announce its earnings on January 26th. ^[1] While we believe that its search company Google continued to dominate the online search ads market in 2016, its ‘moonshot’ (i.e., start-up) businesses, clubbed under other bets, are witnessing downsizing due to investment outlay.

In Q3, the company reported that its revenues grew by over 23% year over year to $22.45 billion. The performance measures for search, cost-per-click (CPC), continued to negatively impact growth. This decline was offset to some extent by the growth in aggregate clicks as Google’s search products as adoption of its enhanced campaigns program continued to gain traction. This program, which combines ad marketing campaigns across mobile devices, desktops and laptops (i.e., across screens with different form factors), was instrumental in generating ad volume growth across both the display and search ad divisions.

In Q4, we believe that Google continued to focus on improving its display revenues from YouTube. Additionally, Google continued 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.

Click here to see our complete analysis of Alphabet

Google Revenue To Grow Despite Decrease In CPC

Trefis currently estimates that PC search ads and mobile search ads contribute over 46% to the firm’s value. During the year, 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 first nine months, it declined by an aggregate 11.3% on Google websites and 6.7% on network member sites. Furthermore, aggregate cost per click declined by 9% during the quarter. The trend in Google’s search ads business is indicative of geographical mix, device mix, currency headwinds and property mix. Furthermore, the growth of TrueView ads on YouTube and the advent of the video programming platform has negatively impacted CPCs, as has the DoubleClick Bid Manager, which monetizes at lower rates than ad clicks on Google.com.

Despite the decline in CPC, Alphabet continued to re-iterate in the year that its monetization rate for mobile devices has improved on the back of increased adoption of mobile ads.  Furthermore, ad volume from mobile devices is growing.  We believe that this trend will help the company to post growth in Q4 and for the 2016.

YouTube Ads To Add To Topline, Weigh On CPC

Trefis currently estimates that YouTube Ads contribute nearly 14% to the firm’s value. In the previous quarter, the company reported that more than 1 billion monthly users are watching hundreds of millions of hours every single day. According to the company, YouTube has become the platform of choice for major brands, with a highly-engaged audience. Research also suggests that many users turn to YouTube to help them in making a decision about buying something by watching videos about it. Going forward, YouTube is an important growth driver for Google as online video ads are expected to grow exponentially. 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 in Q4 and in the ensuing year.

However, Google is focusing on its video programmatic businesses including AdMob, AdExchange, DoubleClick Bid Manager, and these continue to grow at a strong rate. As Google is increasingly looking to monetize the video content through its programmatic platform, Trefis anticipates that CPC (Revenue per search) will continue to decline in Q4 and over the ensuing years. This will result in a lower than expected growth in topline. Although growth in search volume will likely offset the decline in Q4.

Mobile Content And Hardware Sales Set To Fillip Revenue

Google, with 85% market share, dominates the mobile operating system market. The Android OS continues to witness excellent adoption and penetration in the smartphone market with the release of each subsequent version. The widespread adoption of Android will bolsters Google search as a user with an Android phone is more likely to use Google search compared to a user using another OS. Additionally, a user on an android phone is expected to download content from Google Play store, which helped the company to report growth in revenue from content in the first nine months of the year. In order to ensure that the company’s flagship OS continues to rule the roost, Google has launched artificial intelligence based Assistant app that helps users with advanced search. Its mobile services like Now on Tap, which essentially uses machine learning, lets user access additional useful information based on recent search and present location. Last week, the company acquired Twitter’s Fabric, a platform that helps mobile teams to build apps and analyse usage. ^[2] We believe that, as Google’s mobile strategy for content and ads continues to evolve, the ads and content revenues will increase in coming years. Nevertheless, the company will report increase in revenue for its Play store and mobile ads business during this Q4’s earnings report, in our expectatation.

During the year, Alphabet launched the Pixel smartphone to defend its mobile search ad business. ^[3] With the introduction of the Pixel, the firm is looking to create a solid Android alternative to the iPhone, potentially allowing it to win over affluent customers. We expect that the company will disclose the sales number for its Pixel line of Smartphone during this earnings announcement. This will help us to ascertain whether the company was able to compete with Apple’s iPhone in 2016.

Performance Of Other Bets

Its Other bets segment, which includes Fiber, Verily, Calico, Nest, self-driving cars, and other businesses, reported revenue of $548 million and operating losses of $2.23 billion for the first nine months of the year. Other Bets capital expenditures were $884 million, primarily reflecting investment in the Fiber business. Over the past few months, Alphabet is scaling back its support for money-losing “moonshot” ventures to rein in costs and make these businesses accountable for their operations. Despite these efforts, we believe that these businesses will continue to bleed cash in Q4 and 2016, albeit at a slower rate.

We currently have a $821 price estimate for Alphabet, which is inline with the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research

1. Alphabet Investor Relations [↩]
2. ProBeat: Google is buying Fabric, but Twitter is still up for grabs, January 20 2017 [↩]
3. Read more about how this launch will help Alphabet here [↩]