Alphabet Shares Fall After Earnings Miss on Mobile Costs

Google’s Key Ad Metric Stumbles
  • Traffic Acquisition Costs rise as more searches go mobile
  • Internet giant's `Other Bets' unit more than doubles revenue

Even Google isn’t immune to technological change. That was the lesson from the search giant’s quarterly results, sparking the biggest decline in the shares for eight months.

Ruth Porat, chief financial officer of Google parent Alphabet Inc., said late Thursday that profit margins could be pressured by higher mobile phone use and growth in automated ads.

More smartphones mean Google gets its services in front of more eyes. Over 1 billion people now access its Chrome web browser each month on mobile devices. But the company has to pay more to partners to reach users on their phones. That’s also the case as more customers use a fast-growing technology known as programmatic advertising.

"Certain costs associated with revenue are going up given secular trends in the market," Porat said on a call discussing the company’s first-quarter results with analysts. The result is more revenue, "but at a lower margin," she added.

The shares fell 5.9 percent to $733.71 at 1:23 p.m. Friday, the biggest intraday decline since Aug. 24, according to data compiled by Bloomberg. They had risen 44 percent over the past year before Friday’s decline.

Earnings, before certain items, were $7.50 a share, the company said in a statement. That was below analysts’ average projection of $7.96, according to data compiled by Bloomberg. Revenue, excluding payments to distribution partners, rose 18 percent to $16.47 billion, just missing analysts’ forecasts of $16.59 billion.

Traffic acquisition costs, or TAC, paid to distribution partners in the first quarter jumped 33 percent to $1.22 billion, versus a year earlier. That compares with a 20 percent increase in revenue generated from Google’s own websites. 

For the company’s Network business, which runs ads for other websites, TAC rose 5.7 percent to $2.57 billion, driven by programmatic advertising. That compares to a 3.2 percent increase in Network ad revenue.

“The TAC rate is higher on mobile,” Porat said. “Mobile’s growing at a faster rate so what you’re seeing here is a mix shift. Trends driving revenue are accompanied by greater required investment in our ecosystem to support that revenue growth.”

That didn’t sit well with analysts, who have mostly excluded TAC from their estimates in recent years. "Rising TAC, particularly mobile TAC, is a structural issue and could become more material," Ben Schachter, an analyst at Macquarie, wrote in a note to investors Friday.

First-quarter results were also dented by an unusual $213 million loss from the company’s "Other income" line, which included losses recorded on some investments and the impact of currency fluctuations.

Other Bets

There was better news from Alphabet’s Other Bets division, which include its Fiber Internet service, Verily health-care and Nest smart-home companies.

As Google’s ad businesses have expanded, growth has slowed, and the company has sought to make up for that by turning to these new businesses, along with subscriptions and cloud computing services. Last year, Google reorganized into the Alphabet holding company to help it create and build new ideas. So far, growth in further-afield bets have failed to offset the deceleration in advertising growth.

First-quarter sales from Other Bets more than doubled to $166 million. Operating losses excluding equity compensation, widened at a much slower rate, coming in at $657 million compared with $516 million a year earlier.

These big bets, and new core businesses like cloud, will probably lead to more capital expenditure, Porat has said. To compensate. she’s putting in place more cost controls to make Google’s existing money-making businesses more efficient. She’ll also need to offset margin pressure from the new businesses, which will probably be less profitable than search.

"Within Google, we are focused on managing the expenses we can actually control," Porat said.

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