- Google revealed some additional insights on its iOS TAC as a result of disclosures in its Oracle court case.
- Furthermore, the amount Apple receives relative to earnings/sales is small, which provides very little incentive to align its strategy with Google.
- Efforts on Apple's front to mitigate the effectiveness of advertising will remain a headwind for Google.
- However, it's highly improbable that Google's results will be affected too significantly.
We’ve gained additional visibility on the profit share between Alphabet Inc-C (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) when it comes to Google Search queries. At least according to Deutsche Bank analysis, Google pays out approximately 34% of its revenue from iOS search to Apple, which translates to Google’s current traffic acquisition cost, which was reported at 19% in the most recent quarterly earnings conference call. The company doesn’t break out figures specific to its partnerships, but it pays roughly 14% more to position the Google Search app on iOS devices, which is averaged into the consolidated TAC figure. Furthermore, Google doesn’t share the revenue from Siri or Spotlight search, but approximately 91% of all search activity on iOS devices is monetized by both Apple and Google, according to Deutsche Bank.
What this indicates is the loose partnership with Apple and Google is starting to form cracks. As is, Google pays a lot more to maintain its presence within iOS, but Apple has been much more vocal about privacy when compared to Google even though it doesn’t seem to serve the company’s financial purposes all that well. After all, Google uses the data with the intent to serve up more relevant information within search queries or within its own native ad publisher network. This does create some conflict with Apple, as Google’s approach involves taking data from all devices and surfacing the personalized search across different platforms or devices. But if Apple’s approach is to use data within the device to create relevant search or autonomous AI functionality, this breaks down the viability of Google’s search functionality across other non-Apple devices. In other words, the app becomes less consistent with its search functionality, which has negative implications on Google’s conversion metrics, thus lowering CPMs.
As such, where does the dialogue resume for both Google and Apple to come to the table with more reasonable terms? I don’t really know, because the money Google pays Apple per year to maintain Google Search is a really small fraction of Apple’s sales. In other words, the $1 billion Google was estimated to pay Apple in FY’14 doesn’t provide enough incentive for both Apple and Google to share the same philosophy on user data. In other words, it’s just enough to keep the partnership going, but it doesn't prevent Apple from endorsing or implementing ad-blocking software, additional layers of encryption, or prevention of native app API integration in which user information is fed into a third-party ad publisher network.
According to Deutsche Bank:
Our previous calculations estimated total iOS search revenue of $4.8B and $2.6B payout at ~70% TAC rate. This new disclosure suggests that iOS gross search revenue is closer to $4B (see Figure 1, pg. 4). The other $2.6B of Sites TAC (total of $3.6B in 2014) is likely legacy partnerships, toolbars, Chrome distribution and other items, highlighted in our 2013 report “Enhancing" The Mobile Story in 2013 note highlights the rough breakout of the different components of TAC.
Furthermore, it’s worth mentioning that the recent court disclosures in the Oracle case don’t materially alter estimates. Much of the TAC impact is already embedded into both buy side and sell side models as analysts are implementing the consolidated figure anyway. However, if iOS search share increases, it's worth noting that Google’s TAC will increase incrementally due to the mix-shift to iOS queries as opposed to other platforms like Android and Windows. The impact on Apple shareholders though, isn’t really that meaningful even if Apple were to actively mitigate the effectiveness of advertising because it wasn’t much of a needle mover on the company’s P&L to begin with.
While, I can acknowledge the unfavorable dynamics of Google’s relationship with Apple. I feel far more confident endorsing Google due to its relatively limited exposure to hardware and revenue ramp across its platform of apps. I anticipate that Google will sustain margins despite the negative headwinds from iOS due to the steady improvement in ad-targeting across its publisher platform, and anticipate Google Search queries to sustain a healthy CAGR despite usage metric deterioration in developed markets. This is because Search is a relatively new function/feature in many emerging economies where internet isn’t prevalent and even if each incremental international user doesn’t correspondingly produce the same ARPU figures as developed markets, the incremental revenue from emerging markets will remain gross margin neutral as Google’s cost structure has remained stable through international market expansion in the past.
Therefore, I continue to reiterate my buy recommendation on Google. You can also see Amigobulls' Alphabet stock analysis video for a quick roundup of key financials.