Google Misses, Shares Up Regardless - Analyst Blog
Google Inc ( GOOG ) reported fourth-quarter earnings of $9.93, missing the Zacks Consensus Estimate by 41 cents, or 4.1%. CPCs continue to play a major role, accounting for the disappointment versus expectations, even as other aspects of the business such as the number of clicks and non-operating income remained positive. Motorola remained a drag, which the market ignored because of yesterday's announcement. So shares jumped 4.1% after-hours, after rallying 2.6% during the day.
Google's gross revenue came in at $16.86 billion, representing sequential and year-over-year growth of 13.2% and 16.9%, respectively. Google standalone revenue grew 14.2% sequentially and 21.7% year over year.
Revenue from Google-owned sites grew 12.3% sequentially, while partner sites grew 11.8% resulting in net advertising growth of 12.2%. The initiatives to increase the protection of users continued to impact growth at partner sites without which growth would have been stronger.
Both segments continued to grow (22.1% and 2.4%, respectively) from the year-ago quarter. Overall, Google-owned and partner sites brought in 63% and 21% of quarterly revenue, respectively.
Other revenue was up 34.1% sequentially and 99.0% year over year to nearly 10% of revenue. Management attributed the increase to higher Play Store sales (apps and content).
The Hardware and Other segment (Motorola) accounted for a little less than 7% of revenue, up 1.5% sequentially, but staying 24.8% below year-ago levels.
Total traffic acquisition cost, or TAC (the portion of revenue shared with Google's partners and amounts paid to distribution partners and others who direct traffic to the Google website) was up 11.6% sequentially and 7.6% from the year-ago quarter (down 13 bps and 195 bps, respectively as a percentage of advertising revenue). TAC related to AdSense arrangements has been declining in recent quarters, although distribution-related TAC has been increasing steadily.
However, both categories increased significantly in the last quarter. The steady increase in distribution-related TAC is significant, as it is indicative of growing competition for the Google platform. Net advertising revenue, excluding TAC was up 12.4% sequentially and 19.6% year over year.
Total revenue excluding total traffic acquisition costs came in at $13.5 billion, up 13.6% sequentially and 19.4% year over year, slightly higher than our estimated $13.4 billion.
The U.S. generated around 56% of Google revenue, up 44.1% sequentially and 46.4% from a year ago. The U.K., with a 10% revenue share was up 7.9% sequentially and 14.9% from last year. Other international markets accounted for the balance, representing sequential and year-over-year declines of 13.4% and 3.0%, respectively.
The gross margin of 56.0% shrank 464 bps sequentially and 94 bps from last year. Pricing on the Google platform and negative mix impacted the margin. The standalone Google gross margin was 60.2% (down 753 bps sequentially) compared to standalone Motorola's -3.0% (up 3,219 bps sequentially).
The Google gross margin represents a more normal rate this quarter (it had sprung up in the last quarter). The advertising gross margin was the combined effect of an 13% sequential (31% year-over-year) increase in the number of paid clicks, and a 2% sequential (11% year-over-year) decline in the cost per click.
The number of paid clicks and cost per click appears significant, as they are indicative of higher volumes coming at lower prices. This is most likely because of the increasing contribution from the mobile and emerging markets, as well as growing distribution costs.
Notably, similar to the September quarter, Yahoo's ( YHOO ) search business saw slower growth in paid clicks and also a smaller decline in prices. So far, Google's volumes appear to be increasing in huge leaps, which is probably the reason its search business is growing at nearly double the rate of Yahoo's.
Other costs, associated with data center operation, amortization of intangible assets, content acquisition, credit card processing and manufacturing and inventory-related costs increased slightly as a percentage of sales, which also negatively impacted the gross margin in the last quarter.
Operating expenses of $5.50 billion were up 19.3% sequentially and 14.3% from the Dec quarter of 2012. The operating margin was 23.4%, down 631 bps sequentially and down 18 bps from last year. S&M and G&A increased sequentially as a percentage of sales while R&D was slightly lower.
Non-operating gains were $125 million, up from $65 million in the previous quarter and lower than the $152 million in the Dec 2012 quarter.
Google reported net income of $3.39 billion excluding $15 million in restructuring charges (tax-adjusted). This was 20.1% of sales, compared to $3.84 billion, or 25.8% of sales in the Sep 2013 quarter and $2.91 billion, or 20.2% of sales in the year-ago quarter. GAAP earnings of $9.90 a share were down from $11.30 in the previous quarter and up from $8.62 in the Dec quarter of 2012.
Google has a solid balance sheet, with cash and short term investments of around $58.7 billion, up $2.19 billion during the quarter. The company generated around $5.24 billion from operations in the last quarter and spent $2.26 billion on capex, netting a free cash flow of $2.98 billion. Google also spent $120 million on acquisitions.
Google introduced "AdWords Enhanced Campaigns" a couple of quarters back, which enables advertisers to run each campaign across multiple platforms (desktop/mobile), helping them make use of location-based data, generate fresh leads, increase click through rates, improve conversion and increase ROI. While this is likely having a negative impact on pricing and volumes in the near term, the longer-term impact should be positive because advertisers stand to gain.
The competitive landscape has changed a lot in the last few years and the company needs to do all it can to maintain its lead in the advertising market. Its traditional competitor Yahoo is pulling up its socks and Microsoft ( MSFT ) should also not be discounted. But the most dangerous of all is likely to be Facebook ( FB ), which has crept up on the online advertising market. We also anticipate margin pressures as a result of the increasing competition.
At the same time, we note that Google's initiatives in the ecommerce segment (both retail and payment platforms), its Google Fibre initiative, its Nexus and Chromebook platforms, the GDN and DoubleClick platforms, and the success of YouTube make it a power to reckon with.
Google generates revenue primarily from the sale of advertising space on its online properties. It has therefore focused on protecting and growing its position in the search market through continued innovation and quality improvements. This focus has ensured that it remains the dominant player in search across desktop and mobile platforms. Google's Android OS has gone a long way toward cementing its position in the mobile segment. Google has also made acquisitions over time that have augmented its in-house capabilities.
To top it all, Google has shown superb execution to date, as a result of which, its share price has appreciated 50.3% over the past year.
Google shares currently carry a Zacks Rank of #3 (Hold).
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