Alphabet reported mixed Q318 results, they reported a slight miss on sales and beat on EPS, though operating income was lower than expected. Currency (1% drag) and traffic acquisition costs (TAC) were headwinds. Net advertising revenues were up 21% to $27.2B vs consensus $27.3B. Revenue from Google sites decelerated from 26% last quarter to 22% this quarter. Mobile search and YouTube continue to drive ad revenue. Other revenue, which includes cloud, was up 29%. This quarter follows a similar trend of rising expenses and higher capex impacting profitability as they “invest ahead of growth,” particularly, cloud, YouTube and hardware. Higher operating expenses are largely related to head count increases in R&D (tech talent) and sales & marketing. TAC was consistent with last quarter at 23% percent of revenue. TAC is the largest cost of revenue and high TAC levels have been driven by the mix shift to mobile and to programmatic.
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Key Takeaways:
· They are seeing broad based strength in the global ad market with the US growing 20% and APAC growing 30%.
· Amazon ad business is growing ahead of expectations, though still a small percentage of share. Over 50% of product searches are initiated on Amazon…this presents a big ad opportunity for them.
· Google is experimenting with newer ad formats on Maps aimed at “local search” which they view as big opportunity.
· Capex may remain elevated, as they are “very focused on ensuring that we have the needed compute capacity to support growth.” Relative to last year, datacenter construction is an increasing % of their CapEx. They are currently developing more than 20 datacenter sites globally and spending on network infrastructure, e.g. constructing undersea cables.
· Project Stream – game streaming technology with real-time interactions. Pichai called it, “one of the most important technological advances I’ve seen in a while.”
· In the Other Bets segment, which is collectively about 1% of revenue and losing money, Waymo has been piloting driverless cars in Phoenix, AZ and is exploring applying their technology for logistics for last mile delivery solutions in cities.
Valuation:
· FCF for 2019 is expected to be $34B or about a 4.5% FCF yield.
· $102B in net cash, $145/share.
Thesis on Alphabet:
· Online advertising as a share of overall Ad budgets will continue to grow as:
o People spend more time on the internet/mobile internet vs tv, radio, newspapers etc
o Higher ROI (+ easier to measure) per marketing dollar spent online vs other ad mediums
· They are the global leader in search.
· Well positioned to benefit from increased smartphone penetration.
· Flexible business model provides operating leverage with high returns ROIC and huge free cash flow generation.
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Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109
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