Eventually, investors' worst fears about Google may come true. Just not yet.
For all the buzz about Google's self-driving cars and other science projects, Google parent company Alphabet Inc. generates about 90 percent of its revenue from the old-fashioned business (with a Google twist) of advertising. And much of those ad dollars emanate directly or indirectly from Google’s absolute lock on its original business in web search. Essentially the world's second-most valuable company is a one-trick pony -- although it is perhaps the best pony ever created. And if the pony ever goes lame, so does Google.
The horror story about Google’s end days plays out something like this: As more people surf smartphones and not computers, they won't need to search on Google for a new winter coat, a hotel room in Hawaii or the winner of the 1984 Super Bowl. They'll simply go directly to Amazon, Expedia or ask Siri for the answer. If the zeal to Google things slowly ebbs, that will allow Facebook and others to chip away at Google's commanding share of the $200 billion global market for online advertisements.
Despite an earnings miss on Thursday, it's tough to find evidence that the pony is anywhere close to be putting out to pasture. Alphabet said on Thursday that its revenue excluding payments to advertising partners rose 23 percent in the fourth quarter of 2016 from a year earlier. That was the company's 12th consecutive quarter of at least 13 percent net revenue growth on a year-over-year basis, according to Bloomberg data.
It is extremely unusual for companies with $90 billion in yearly revenue to grow so quickly. Amazon.com Inc. and Chinese e-commerce website JD.com Inc. are among the handful of giant companies with a faster rate of sales gains than Alphabet. Neither of them has operating profit margins anywhere close to Alphabet’s 25.5 percent in the fourth quarter. In short, Alphabet is huge, incredibly profitable, added $15 billion in new revenue in 2016 and has by far the best technology in the giant market for internet advertisements.
Google continues to grow because it keeps coming up with new ways to squeeze more advertising dollars from its command of the intricacies of the internet and troves of data on how people spend their digital lives. It has been dialing up the number of ads it sells next to many Google searches on smartphones. Trying to steal a page from Amazon, Google is also becoming more sophisticated in paid product placements in digital catalogs.
The number of clicks on ads sold by Google rose 36 percent in the fourth quarter, the best gain in years. Even subtle improvements in Google’s ability to get people to click on digital advertisements really add up for a company that touches nearly everything people do online or on their phones.
Even the worst fear -- that people would stop searching on smartphones -- hasn’t panned out yet. Google has said that more than half of its web searches are on mobile devices. It’s hard to know exactly how individual parts of Google are doing, but RBC Capital Markets estimates ad sales for the company’s core web search operation are growing by a low-to-mid teens percentage each year. On a call with analysts on Thursday, Google CEO Sundar Pichai said the web search business has "lots of headroom ahead."
And while YouTube isn’t quite living up to its financial potential, that valuable asset plus early efforts to turn Google Maps into a billboard for advertisements will be surefire future sources of revenue growth. That means even if Larry Page’s various experiments in driverless cars, curing the world’s diseases and internet-beaming drones never pan out, Alphabet should still do just fine.
The worst fears about Google may come true someday. People may eventually stop searching. The burning piles of cash from Page's nonadvertising projects could drag the company down. Regulators in Europe and beyond are keeping close watch on Google’s growing power and could move to curb it.
For now, however, the constant stream of new types of ads in more places -- combined with Google's reams of consumer information -- is keeping the Alphabet advertising engine churning. The one-trick pony should keep galloping for years to come.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
It’s amazing how little is known about the financial performance of individual parts of Alphabet. Even for YouTube, one of Google's biggest businesses, its number of users and annual revenue are unclear.
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