With its self-driven car, Google (NASDAQ:GOOG) has set out to bring to life what used to be science-fiction in 1980’s. To those who remember, the thought of it brings back memories of yesteryear's popular TV series ‘Knight Rider’, featuring a dream car that could make it to almost everybody’s wish-list. But even as Google forays into a multitude of jaw dropping pursuits, it is the company’s core business that propels them.
In 2013, advertising, which is at the heart of Google’s revenue model earned it nearly 85% of its revenues. Over the last couple of years, the growth in ad-revenues for Google has slowed to reach 16% in FY 2013. However, there are enough reasons to be optimistic about Google’s growth engine.
Google Revenue Growth
|Total Revenue (in million $)||37.9||50.1||59.8|
|Total Ad Revenue (in million $)||36.5||43.6||50.5|
|Ad Revenue from Google sites (in %)||72||71||74|
|Ad Revenue from network partner sites (in %)||28||29||26|
Apart from hosting ads on its own sites, Google also places ads on partner sites in its ad network. Most commonly these ads generate revenue when clicked on by users.
In Q4 2013, paid clicks grew by 31% Y/Y and revenue from ads on its own sites grew much faster at 22% Y/Y as against a 3% growth in revenue from its ad-network. Given that clicks on Google’s own sites fetch the company a higher revenue than clicks on its ad-network, the company will be hoping for this trend to continue.
The growth is a result of increased search activity, which we believe is only going to grow, and a number of new measures and metrics that Google has been rolling out in its bid to build confidence among advertisers about digital advertising.
Key drivers for Google’s future growth
In 2013, Google introduced ‘Enhanced Campaigns’ to help advertisers create ad-campaigns that run across multiple devices. As per Google’s claims, the benefits of the move have started coming through and it has received positive feedback from advertisers who are reporting better ROIs on their ad-spends. Another move that is likely to enhance its credibility as an ad-host is the launch of its ‘Estimated total conversion’ metric which will help advertisers better assess the conversion rates for their ads.
Google has become an important cog in the brand management wheel, and opening up to Nielsen Holdings’ Online Campaign Ratings (OCR) could be the move that takes it to the next level. For about two years, Google had been refusing to let Nielsen place its performance tracking tags on its ads on YouTube, thus dissuading a few advertisers from placing ads on the site.
However, advertiser confidence is the key and Google has understood that all too well. While it works on developing a host of its own metrics to measure the efficacy of ad-campaigns, opening the door to Nielsen allows marketers to track performance via a third party metric. Nielsen’s tags give advertisers information like, ‘how many people saw the ad ‘and ‘how often’, to demographics of the viewer with help from Facebook. Many believe that the results of this study could catalyze the movement of TV ad spends to digital formats. Either way, a better understanding of performance will only improve what Google has to offer to advertisers.
In one masterstroke, Google recently tied up with Russian search giant Yandex (NASDAQ:YNDX) to allow each other’s clients/advertisers to bid for display-ad space on each other’s partner networks. Yandex is difficult to dislodge in Russia and has been gaining market share in Ukraine and Belarus, where it just overtook Google in terms of market share. This is also what Google did with Facebook (NASDAQ:FB) in October last year.
The cross selling of ad inventory is carried out via an RTB or real time bidding system where buyers bid to acquire ad-space. Estimates are that by 2017, these RTBs will account for 29% of digital display ad spend in the U.S. In addition, Google will be allowing Time Inc. to use its platform to sell ad-space across all of its global sites. The arrangement will add extra revenue to Google’s tally, and this could be the next growth driver for the company.
In Q4 2013, Google’s revenue from regions other than the U.S and the U.K grew twice as fast and that trend could continue as emerging nations add new users to the internet. Google’s ‘other revenue’ from non-core businesses like hardware (Nexus series handsets) and digital app sales (Google Play store) is also poised to grow at a brisk pace after nearly doubling on a Y/Y basis in Q4 2013.
The company has indicated the possibility of a contraction in operating margins on account of higher traffic acquisition and data center costs. However, that has also been the case with Yandex, and therefore might not be a cause for excessive concern. Further, at an EPS level, if all the factors that we discussed earlier start to kick in, the revenue growth could offset the fall in margins.
Apart from being confident about its business fundamentals, at its current price, we are bullish about Google the stock.
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