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Google Surpasses Expectations, But Investments Hurt Profits

Posted on Thursday, Feb 7th 2019

Earlier this week, Google’s parent Alphabet (Nasdaq: GOOG) reported its fourth quarter performance. While the company surpassed market expectations for the quarter, rising costs and lower advertising prices are hurting its profits. The market was not happy, and in the after-hours trading session, the stock fell 3%.

Alphabet’s Financials

Alphabet’s fourth quarter revenues grew 22% over the year to $39.28 billion, significantly ahead of the market’s forecast of $38.93 billion. Traffic Acquisition Costs came in at $7.44 billion, compared with the Street’s forecast of $7.62 billion. Alphabet ended the quarter with a net income of $8.95 billion, compared with a net loss of $3 million recorded a year ago. Adjusted EPS came in at $12.77 compared with $10.82 expected by analysts.

By segment, Google’s advertising revenue grew 20% over the year to $32.64 billion, with Google Properties contributing $27 billion in revenues and its Network Members’ properties bringing in the remaining $5.6 billion. Other revenues for Google grew 31% over the year to $6.49 billion, compared with the market’s forecast of $6.43 billion. This segment includes revenues from the Cloud. But Alphabet did not break out the revenues for Cloud services separately. Revenues from Other Bets came in at $154 million compared with the market’s estimates of $187 million. The Other Bets segment continued to report losses and ended the quarter with a net loss of $1.3 billion, compared with a loss of $748 million reported a year ago.

Among operating metrics, paid clicks on Google properties jumped 66% and cost per click fell 29% over the year and 9% over the quarter. The reducing cost per click is causing alarm among investors as it signals a loss in Google’s pricing power. Some believe the erosion is driven by the mounting pressure from the likes of Amazon which is increasing its presence in the digital advertising segment. Within the non-Google properties, impressions on network members’ sites grew 7%, and cost per impression rose 5% over the year.

Alphabet ended the year with revenues growing 23% to $136.82 billion and a net income of $30.7 billion.

In some other interesting metrics, Alphabet’s capital expenditure doubled last year, making it the fastest expansion in the last four years. Total capital expenditure for the year grew 102% to $25.46 billion with fourth quarter spending growing 80% to $6.85 billion. Alphabet has been investing heavily in building data centers, cloud computing capabilities and facilities to ensure it is able to deliver growth.

Alphabet’s Growth Drivers

Alphabet has been focusing on leveraging AI capabilities. Recently it brought some more AI features to its service such as the Smart Compose feature for Gmail and the call screening on Pixel. It also launched the Google AI impact challenge to help non-profits find ways to use AI for solving social and environmental problems.

Alphabet continues to invest in the Google Assistant’s capabilities. Over the past year, the Google Assistant has grown from 8 languages and 14 countries to nearly 30 languages and 80 countries. It also demonstrated additional capabilities at CES such as real-time navigation that helps users during their commute and a built-in interpreter that translates conversations across dozens of languages on Google Chrome.

Within search, it launched Activity Cards that act as a bookmark for Search. Now, when users search for a topic that they have previously explored, they can quickly see where they have already been and pick up from where they left off. Within phones, it announced that Android will soon officially support foldable phones as its partners work to introduce their first foldable devices this year.

YouTube continues to be a big focus area, and it is seeing traction in its newer experiences. YouTube Music and YouTube Premium are now available in nearly 30 countries, compared with five at the start of 2018. YouTube TV also announced plans to expand its reach nationwide to cover 98% of US households. Some of the other features added to the service include access to tools like stories and community posts that help build connections between fans and content creators. YouTube advertising continues to grow as well. Recently, Warner Brothers embedded the first full-length film with an ad on YouTube and was able to reach a record number of 17 million users in a single day.

The market has been hoping that Alphabet would reveal more details on the financials for its cloud segment. While it did not divulge details on the result announcement, earlier this year, it mentioned that together the G Suite productivity apps and the Google public cloud for hosting apps were operating at a $4 billion annual run rate. That is still relatively small when compared with Amazon’s $7 billion revenues recorded in the recent quarter for its AWS segment. During the quarter, Alphabet more than doubled the number of Google Cloud platform deals over $1 million and the amount of multi-year contracts that it has signed.

Late last year, Alphabet appointed former Oracle executive Thomas Kurien as its head of the Cloud business. Many believe that Kurien will be able to deliver rapid growth in the segment and will also be looking at acquisitions to drive this growth. Alphabet ended the fiscal with nearly $110 billion in cash and equivalents. But it is spending its cash very wisely and claims to have a very high bar for acquisition targets. It is rumored that the company was evaluating the acquisition of both RedHat and GitHub, but decided to give the deals a miss. Over the last quarter though, it has added a few other smaller players to its portfolio.

It started this year with the $60 million acquisition of Superpod, a startup founded by former Google employees that has built a question-and-answer app. Superpod’s app lets users post questions and it provides them with expert answers within an hour. The acquisition is expected to be part of the acqui-hire strategy to help Google improve the Assistant’s prowess. Prior to the acquisition, the California-based company had raised an undisclosed amount of seed funding.

This was not the only Assistant focused acquisition that Google made recently. Last quarter, it acquired Onward, a San Francisco-based customer service automation platform that helps its clients automate tickets and messages. Onward’s enterprise visual bot uses natural language processing to decipher meaning from customers’ messages to help address them faster. Prior to the acquisition, Onward had raised a modest $120,000 in funding. Terms of the acquisition were not disclosed.

Alphabet also made an education-focused acquisition of Workbench. Baltimore-based education technology firm Workbench offers a content platform that can package content into custom, engaging learning and interactive experiences. It provides an online library of lessons and projects that have been organized by subject and grade level that can be used by educators. It also offers a programming interface where students can perform coding exercises and control bluetooth-connected devices that are integrated with the platform. Workbench is no stranger to Google and is already integrated with Google Classroom. Terms of the acquisition were not disclosed. Workbench had raised $3 million prior to the acquisition.

Its last acquisition in fiscal 2018 was that of Bengaluru-based Sigmoid Labs. Sigmoid Labs was founded in 2013 and is known for its app Where is My Train. As the name suggests, the app lets users track live train updates without an internet connection. Since being released in 2016, the app has seen more than 10 million downloads and became the leading app in Google Play’s Travel section. Sigmoid Labs’s financials and funding details are not known.

Alphabet is slowly adding several smaller and bootstrapped companies to its portfolio. What other companies do you think it would be interested in buying?

Alphabet’s stock is currently trading at $1,153.23 with a market capitalization of $778.9 billion.  It touched a record high of $1,273.89 in August last year. It has grown from the 52-week low of $970.11 that it had fallen to in December last year, when most technology stocks took a tumble.

Photo credit: Thomas Hawk/Flickr.com.

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