Over the past three months Google’s shares have been on a seemingly unstoppable journey all the way to $1000, rising 19 per cent over the period.
However, upon release of the company’s second quarter financials the stock has hit a rare speedbump, down 5 per cent in after hours trading on results that missed market expectations.
In some ways Google is the victim of its own success. It has enjoyed a decade-long tear of growth, but that has created an expectation that the company will outperform the market and continue to provide large gains to shareholders. Although Google is at pains to point out that the company isn’t a conventional one – and will pursue innovation and long-term goals over short-term, market motivated gains – the company is still beholden to quarterly reporting results whether it likes it or not.
In a nutshell, Google reported the following performance measures:
– Total revenue up 19 per cent year-on-year to $14.1 billion (from $11.8 billion for the same period in 2012).
– Google.com properties revenue up 15 per cent year-on-year to $8.67 billion (from $7.54 billion for same period in 2012).
– Motorola Mobility revenue up 18 per cent year-on-year to $998 million (from $843 million for same period in 2012).
– Network revenue up 7 per cent year-on-year to $3.19 billion (from $2.98 billion for same period in 2012).
– Other revenues up 138 per cent year-on-year to $1.046 billion (from $439 million for same period in 2012).
– Total expenses up 78 per cent year-on-year to $10.98 billion (from $8.57 billion for the same period in 2012).
– Net income reported for the quarter of $3.228 billion (up 16 per cent year-on-year) – a figure dragged down by a $342 million loss for the quarter for Motorola Mobility.
Thus revenue up and net income up – so what has spooked Wall Street?
Most likely one – or more – of the below:
Expenses are rising fast (which is acceptable for a company as entrepreneurial and adventurous as Google) and for the second quarter were up 78 per cent year-on-year. However, there’s little visibility around where these additional expenses are being utilised and how these areas are performing.
Costs represent 78 per cent of revenues for the quarter, up from 73 per cent for the same period in 2012. All this even with Motorola headcount sitting at 4599 at completion of the second quarter, down from 15,152 at the end of the first (mainly due to offloading parts of Motorola to other companies).
Merrill Lynch asked on the earnings call whether any products were operating at gross negative margins – Google dodged the question. This is a concern for investors, which products – aside the pillar products like network, search and YouTube – are providing meaningful profit? Right now it’s hard to know.
Network revenue growth is slowing. For the quarter it was 7 per cent. For the previous one it was 12 per cent. For quarter one in 2012 it was 20 per cent.
It’s unclear what the cause of this is but it’s worth noting. Selling advertisements on sites owned by other companies has been a good earnings grower for Google over the years, using its immense data cache on its users and their intentions across other properties. Perhaps Google is directing more of these advertisers onto their own platforms such as YouTube and Gmail.
Google sites are up 18 per cent for the quarter. Performance is still stronger than the overall digital advertising market, however it’d be helpful to have more clarity around where Google’s revenue – especially revenue categorised within reports as ‘Network’ or ‘Google sites’ – is actually falling, specifically around search, display mobile, video and programmatic. Still, even without this visibility the future performance of Google appears likely, driven by its unmatched consumer data and network reach.
Given Google’s reliance on its core paid search business, which is the dominant contributor of revenues and the overwhelming majority of profit for the company, analysts continue to focus closely on the key metrics of paid search volume and cost per click.
Cost per click has been on a downward trend since the beginning of 2012 and appears to correlate with increased use of search by consumers on mobile at the expense of desktop search. This cost per click has been going backwards now for the past seven quarters and is indicative of the conundrum the migration to mobile. This graph from Quartz demonstrates the issue in terms of yield.
While cost per click is dipping, encouragingly total searches are increasing significantly (as demonstrated here). This problem is similar to what traditional media companies also face – consumers are naturally migrating to areas that are lower yield. For Google this involves users moving from higher yield desktop search to lower yield mobile search (whereas for a company like Newscorp it’s more about consumers and advertisers migrating from higher yield print products to lower yield digital products).
Investors will continue to monitor the above areas, specifically around cost per click and expenditure levels. And while the stock is down after the release, let’s just pause to consider that in the three months ending June 30, Google generated an additional $2.3 billion in revenue compared to the same period in 2012. A result of $2.3 billion demonstrates that the company is still an outstanding performer.