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Alphabet Outperforms Expectations, But the Market Wants More

Posted on Tuesday, Aug 1st 2017

Alphabet (Nasdaq: GOOG) recently announced its second quarter results that outpaced market expectations driven by robust performance in both the mobile and YouTube offerings. But despite the better than expected results, the stock slipped a bit as the market reconciled with the rising Traffic Acquisition Costs (TAC).

Alphabet’s Financials

Alphabet’s second quarter revenues grew 21% over the year to $26 billion, ahead of the Street’s forecast of $25.57 billion. EPS of $6.01 was also significantly ahead of the market’s forecast of $4.44 for the quarter.

During the quarter, Alphabet was slapped with a $2.7 billion fine by the European Union. The Commission claimed that certain actions taken by the company regarding its display and ranking of shopping search results and ads were not in line with the European competition law. Excluding the fine, Alphabet would have recorded an EPS of $8.90 for the quarter.

By segment, revenues from the Google properties grew 20% to $18.4 billion. Revenues from its members’ websites grew 13% to $4.2 billion. Other revenues which includes revenues from non-ad businesses including the Play Store, cloud app, and infrastructure sales and hardware grew 42% over the year to $3.1 billion. Revenues from Other Bets grew 34% to $248 million.

Among operating metrics, aggregate paid clicks grew 52% over the year and 12% sequentially. Paid clicks on Google websites grew 61% over the year and paid clicks on members’ websites grew 15% over the year. Aggregate cost per click fell 23% over the year with a 26% decline registered on Google properties and a 11% decline on Network Members’ properties.

Alphabet’s TAC has been on the rise causing concern regarding its long-term profitability. During the quarter, TAC to Google Network Members as a percentage of Google Network Members’ properties revenues came in at 72% compared with 70% a year ago. TAC to distribution partners as a percentage of Google properties revenues grew to 11% from 9% a year ago. Total TAC as a percentage of Google advertising revenues grew to 22% from 21% a year ago. Alphabet claims that the higher TAC rates are associated with mobile sites and programmatic buying.

Alphabet’s Growth Focus

Alphabet has been focusing on three key growth areas – YouTube, Cloud, and the Hardware businesses. YouTube now has more than 1.5 billion monthly viewers who spend an average of an hour a day watching videos on their phones and tablets. YouTube watch time on TV screens has nearly doubled year-on-year as Alphabet continues to add content on the service. During the quarter, it launched six new ad supported YouTube originals which include content from celebrities such as Ellen DeGeneres, Kevin Hart, and Rhett & Link. It also expanded the Live YouTube TV service to ten new metro areas across America.

Within the cloud, its Cloud Platform (GCP) continues to deliver impressive growth. During the quarter, the number of new deals worth more than $0.5 million closed by Alphabet were three times more than the previous year. To support the growing demand, it opened new Google Cloud regions in Northern Virginia, Singapore, Sydney, and London. Alphabet also entered into an expanded agreement with SAP and a new partnership with Nutanix to integrate their products with its cloud offering. The partnerships will allow organizations to run workloads in hybrid environments.

Google does not break out the details of its cloud revenues separately. But it believes that its cloud business can generate more revenue than its digital ad business – which currently accounts for nearly 90% of its revenues. It also believes that it could outpace Amazon to become the world’s largest cloud infrastructure vendor within the next five years. That is a huge dream to fulfill considering that Amazon has a tremendous lead and Microsoft is gaining fast with Azure. The following infographic, courtesy Market Realist, shows how far Amazon is ahead of the pack.

Alphabet is also pleased with the performance of its Hardware business. Google Home is now available in the US, Canada, Australia, and the UK and will soon be released in France and Germany. It has more than 70 home automation partners on the Assistant on Google Home and Phones, including Honeywell, Logitech, and LG to improve AI capabilities on these devices. Recently, it also announced that Google Lens will be made available later this year. Lens will offer vision-based computing capabilities so that users will be able to get more information about things that they are looking at.

Meanwhile, it continues to improve its core offerings. For instance, within search it launched a US job search capability. It is also supporting the vacation rental industry by showing those results as part of hotel searches.

Alphabet’s stock is currently trading at $930.5 with a market capitalization of $649.35 billion. It touched a record high of $988.25 in May this year. It was at a 52-week low of $727.54 in November last year.


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