Quick Thoughts: Another Annoying Google Quarter

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–          While GOOG’s 1Q14 miss is disappointing, it is not particularly unusual in its history of focusing on the long term. To that end, 19% sales growth is a healthy indicator for the future.

–          Network ad sales grew just 4% as GOOG is capturing more ad dollars on its own sites through programmatic ad buying. TAC is now at a record 3 year low of 23.3%

–          The bottom line miss was exacerbated by a 400bp boost to OPEX, mostly due to unusual legal expenses and costs associated with integrating Nest that will be resolved by next quarter.

–          The miss had GOOG off over 3% after hours. We do not see the results as alarming, and would use weakness as an opportunity to add what we see as the best positioned player in the sector.

Earnings happen. Google, like its archrivals Amazon and Facebook, maintains a blasé attitude toward its short term results. This long-term approach, while ostensibly to be applauded, has an annoying tendency to periodically bite investors in the portfolio. Google’s first quarter report is an example of this habit. The numbers were short on both the top and bottom lines, and the stock tumbled after hours, eventually recovering to just 3.15% down. In its past 4 misses, Motorola’s hardware business was the prime culprit, but this time it seems to be a bit of over exuberance in sales estimates combined unusual items that drove OPEX up 400bp. Legal fees likely stemming from the recent stock split drove G&A up, while Nest’s heavy R&D flowed through the P&L taking the company from a historic R&D rate of 12% of revenue to 14%. Despite this little speed bump, things look more than alright in Mountain View.

Google, now more like a 1200lb Gorilla, continues to grow ad revenue prodigiously as it dominates internet advertising globally.  Google sites ad revenue, which makes up 68% of total sales, was up 21% over 1Q13 to $10.47B on a 26% YoY increase in paid clicks despite an offsetting 9% decrease in average cost-per-click. Though paid clicks were down -1% QoQ, comparing these quarters consecutively isn’t meaningful given higher than normal ad spending around the holiday quarter. Google’s own sites have benefitted from programmatic ad buying drawing more dollars to its properties. Network ad revenue earned from third party sites, which makes up 22% of Google’s topline came in at $3.4B and was up only 4% YoY, but down -4% QoQ. This segment has been growing slowly in the last year given advertisers are likely opting to advertising on Google sites directly. This is also evident as TAC continues to decline and just hit another 3 year low at 23.3%. Google will start to break out CPCs and Paid clicks for these segments starting next quarter.

Google has plenty of room to keep the advertising growth on its own sites going, as it continues to innovate, introducing new ad products like enhanced campaigns and product listing ads. The company continues to engage actively with Madison Avenue, partnering to promote this year’s Super Bowl commercials on YouTube and attracting 300M views. It is also due to present a new cross-platform offering at its Brandcast upfront event that will leverage Nielsen and ComScore measurement. I’m optimistic Google can prove better ROI for advertisers than traditional TV advertising, and the unfortunate history of the newspaper industry hangs like a specter. The developments at the upcoming network upfronts will be interesting indeed.

Of course, Google is increasingly more than advertising. Other revenues, which include everything in Google that is NOT advertising, came in at $1.05B up 48% YoY. It’s difficult to find a theme in tech where Google has no exposure. From devices (Nexus, Chromecast, Chromebook) to broadband (Google Fiber) to cloud (Google Cloud and App Engine) to content (Google Play), Google has its fingers all over TMT. While these businesses were non-existent three years ago, they’ve enjoyed early successes. Google’s Chromecast is a best-selling streaming device, while municipalities around the country are trying to woo Google into building Fiber in their communities. The company also expanded the Play store into 65 countries and its recent deep price cuts for cloud services were positively received in the marketplace. But Google is not sitting idle and is continuing to invest heavily in proven technologies such as growing data center capacity and is also making well calculated acquisitions.

While Nest had a one-time negative impact on the P&L this quarter, it’s a huge play for the connected and energy efficient smart home. It continues to explore products and services that are still far from proof of concept. Its internal moonshot projects like self driving cars, Project “Loon” and a string of robotics acquisitions as well as the takeout of Titan Aerospace this week show a vision beyond advertising. Not caring so much about its quarterly results has allowed Google to pump investment toward potentially large and lucrative opportunities to exploit its extraordinary data processing prowess. These investments will make it devilishly hard to beat.

For our full research notes, please visit our published research site.

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