Google ( GOOG ) posted its second quarter 2015 results on July 16th, reporting 11% year-on-year growth in revenues to $17.72 billion, in line with our expectations. However, the highlight of the result was the 2% year-over-year decline in costs and expenses, which stood at 66% of revenues. The markets reacted positively to the results as the stock was up by 11% in the aftermarket trading hours. While the cost in absolute terms was higher, its decline as a percentage of revenues boosted operating profits. Google's operating income from continuing operations increased by 200 basis points (or $800 million higher) to $5.95 billion. Furthermore, the company reduced its capital expenditure on data center for the first time in three years. This signals that the company might be scaling back its data center expansion efforts. However, pricing pressure on online ads resulted in a 11% year-over-year decline in aggregate cost-per-click (CPC). However, aggregate paid clicks, which represent the number of ads served across Google properties and its member website, grew by 18% year over year. In this note, we will discuss Google's results.
Company Reins In Costs, Boosts EPS and Operating Cash Flow
During the quarter, Google was able to rein in costs related to traffic acquisition (21.1% of revenues compared to 23% in Q2 2014), and general & administrative (8% of revenues compared to 9% a year ago). This signifies that the company is maintaining a tight leash over sundry expenses, which have impacted the bottom-line in the past. As a result of these efforts, Google's non-GAAP diluted EPS was at $6.99, higher than $6.70 market consensus. Furthermore, its operating cash flow was a healthy $7 billion.
Programmatic Platform Buoys Number of Clicks Grow Even As Cost-Per-Click Continues To Decline
We currently estimate that PC search ads and mobile search ads contribute approximately 67% to the firm's value. Online ad spending is expected to increase in general and reach $155 billion in 2015. 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 past few years. While the recent trend is indicative of geographical mix, device mix, currency headwinds and property mix, the company has stated that it will continue to monetize mobile devices effectively and the decline has been due to TrueView ads, which is a growing percentage of overall sites clicks mix, that monetize at lower rates than ad clicks on Google.com. As a result, the aggregate CPC (CPC for both mobile and PC from search and display) declined by 16% year over year for Google sites during the quarter.
However, Google is looking to monetize its properties through its programmatic platform, which matches relevant ads with content, as well as through an increase in user-generated online content. However, this is negatively impacting Google's CPC as the programmatic platform does away with inefficiencies of improper ad matching. As a result, the company's top line growth from search ads has failed to match the growth in search volume. Google is focusing on its programmatic businesses including AdMob, AdExchange, DoubleClick Bid Manager, and these continue to grow at a strong rate. Going forward, as Google improves its programmatic platform, we expect that the growth in online advertising will grow but continue to weigh on CPC.
Revenues From Mobile Ads To Grow
The mobile search ads division is the second largest division for Google and makes up approximately 34% of its total value, according to our model. Google, with 90% market share, dominates the mobile search engine market. One of the key reasons for this dominance is its flagship Android OS, which has witnessed excellent adoption and penetration in the smartphone space. Android is now used by over 400 OEMs and over 500 carriers, who make over 4,000 distinct devices.
A user with an Android phone is more likely to use Google search compared to a user using another OS. This is especially relevant when competing with OS's such as Apple and Windows Phone use their own search engines on the mobile devices. In Q2, Google reported that more searches now take place on mobile devices than on computers in ten countries, including the U.S. and Japan, two of its largest markets. In fact, 30% of mobile queries are related to location. Google has stated that the gap is tightening on pricing (CPC) between mobile and desktop. It stated that mobile CPCs are up and desktop CPCs are stagnant so the gap is narrowing. As part of its strategy, it remains focused on building the mobile ecosystem that has the right ad formats and measurement to take advantage of all the platform ads, and offer features like estimated store visits, app install, the re-engagement ads, cross device conversions. Furthermore, it continues to explore ways to monetize mobile devices and has introduced new mobile ad formats like automobile ads, which take you directly to a carousel of vehicle images important details like estimated MPG, and links to nearby dealer listings. We believe that as the multi-platform enhanced campaigns program continues to evolve and adoption rate goes up, the aggregate paid clicks would increase and boost the number of ads sold in coming quarters.
Google Play Store for Content
The Google phone division makes up 10.5% of its estimated value. Considering the growth of Google's Android platform and the growth in smartphone adoption globally, Google's Play store is fast becoming a vital cog for Google's growth in the coming years. Google Play is also connecting developers and content providers with more than 1 billion people on Android devices around the world. Developers are building thriving businesses in this platform, and in February, Google announced that over the past 12 months (FY 2014), it paid more than $7 billion to developers. We expect this figure to grow and forecast digital content revenue to grow to $8.51 billion (post revenue share of developers) by the end of our forecast period.
YouTube Boosts Ad Volumes
In our pre-earnings note, we mentioned that we would be closely watching YouTube because it caters to the rapidly growing online video ad market. During the earnings call, we got some encouraging metrics from management, which makes us confident about YouTube as an essential driver of revenue growth, going forward. Management stated that the watch time on YouTube increased by over 60% in Q2. Watch time of YouTube on smartphones has improved by 100% to 40 minutes per viewing session. As a result of YouTube's success, the number of advertisers running video ad on YouTube is up more than 40% year over year and the average spend per advertiser is up over 60% year-over-year. Going forward, YouTube is important for Google even though, according to our estimates, this division constitutes just under 3.4% of its value.
Capitalizing on the Popularity of Android With Play Store
Google's phone division makes up 8% of its value. Google continues to leverage the growing popularity of its Android operating system with app sales on its Play store. Furthermore, Google's apps (such as Google Play, Search and the YouTube app) have over 50% reach for the mobile audience according to comScore. This was reflected in the growth of Google's other revenues, which grew by 17% year over year to $1.7 billion, and is primarily composed of revenues from sale of digital content. Going ahead, we expect revenues from digital content to grow to $5.6 billion by 2021, bolstered by the increasing use of Internet to deliver content such as movies, books and music.
Capital Expenditure Declines For The First Time In Three Years
Google scaled back investment in Internet infrastructure and reported $2.5 billion in capital expenditures in the second quarter of 2015. The majority of capital investments are for IT infrastructure, including data center construction, servers and networking equipment. The company said that the CapEx spend was lower versus last year and last quarter - reflecting a bit of a digestion period after an extended period of investments in both data centers and the requisite machine deployment. Before this cut back, Google was steadily ramping up its spending on data centers for the past couple of years, in an effort to improve its computing capacity and quality of service. Both these are important as it gives the company a competitive advantage.
We are in the process of updating our model. We currently have a $552 price estimate for Google , which is 5% below the current market price.
View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap