- Google missed on revenue and earnings this quarter, which was broadly unanticipated.
- The company struggled with foreign exchange, traffic acquisition cost and higher capital expenditures.
- However, I anticipate the stock to recover given better mobile monetization and reset of analyst expectations.
Alphabet Inc-C (NASDAQ:GOOG) really struggled coming out of the quarter as the stock was down by 5.32% following its earnings report. However, I remain bullish on the company as expectations have reset and investors/analysts are getting more acclimated to another investment year in some of its other categories like content licensing for YouTube Red and Google Fiber.
The fiber to the premises build out will be extremely costly as the management team mentioned that $280 million of the capex was due to Google Fiber, which represented roughly 14% of Google’s capex for Q1’16. Since Google Fiber doesn’t contribute significantly to revenue and is also capital intensive, the business contributed to the operating loss of the “other bets” segment. In Q1’16 Google’s other bet segment reported $802 million operating loss, which compared to the prior quarterly loss of $633 million. I believe the widening of other bets losses and the higher traffic acquisition costs (TAC) contributed significantly to the quarterly earnings miss. TAC widened as a percentage of revenue from 21% to 22% between Q1’15 and Q1’16, which was due to mobile mix-shift. Google pays a higher percentage for acquired traffic from Apple iOS devices, which explains the cost de-leveraging in the most recent quarter.
The company reported revenue of $20.26 billion, which compared to consensus estimates of $20.32 billion. Alphabet also reported non-GAAP EPS of $7.50 versus consensus at $7.96. The company missed EPS expectations by 5.77%. Alphabet usually has a great track record of exceeding estimates, so the miss on expectations was a true shocker.
The company repurchased $2.3 billion in stock and has $1.4 billion remaining in its authorization. Needless to say, the company will be revisiting its buyback authorization, as the company sits on plenty of foreign cash. This may prompt Google to borrow cash to buy back its shares domestically in the United States.
However, Google has only recently started returning capital to shareholders, so the timing of buyback authorization has yet to be formalized into an annual cadence. As such, knowing exactly when Google will revisit its buyback authorization becomes difficult, however Google may look to repurchase more shares in 2H’16, as the company seems more focused on organically growing its business, which diminishes the likelihood of using foreign cash for foreign acquisitions. The company currently has $73.066 billion in cash/equivalents of which most is in some offshore tax shelter holding company.
The company also struggled with its F/X hedging program. As you are well aware, the dollar declined quite considerably since Q4’15, which implies that a good chunk of Google’s hedges lost money, as the company reported market adjustment losses. This is due to the miss-execution on F/X hedges, which became unnecessary given the V-shape recovery in many foreign currencies. The marketable and non-marketable security adjustments swung to -$299 million in Q1’16.
So, despite all of the positive data on core advertising revenue, the company struggled on the top line as expectations were quite elevated going into the quarter. The miss-execution on expenses and revenue wasn’t really anticipated as a lot of the sell side commentary (which is way more conservative than buy side mentality) anticipated acceleration to top line revenue. Coming out of the quarter many on the sell side have revised estimates and price targets lower (less expectation risk going into 2H’16).
Of course, Google doesn’t provide revenue/margin guidance, so there will be surprising quarters down the road. The management team doesn’t provide specific expense or revenue targets plus the data points on cost per click and engagement metrics are hard to model into a predictable revenue forecast. As such, there’s a great degree of variability among the consensus as the estimate revisions are usually reactionary. There’s not a lot that can be done to improve forecast assumptions until Ruth Porat (CFO of Google) provides outlook on revenue/margins, which probably won’t happen for quite a while.
Here’s a brief snapshot of estimate revisions from sell side analysts:
Adjusting our model, we think the Websites business can still grow 21% ex-FX in 2016...which when combined with improved opex discipline will generate $35.5bn of 2016 non-GAAP EBITDA and $33.40 of non-GAAP EPS. Adjusting our model, lowering PT to $850: Adjusting our model we are lowering our 2016 gross revenue estimate by ~1%. Our gross profit falls by ~3% due to lower gross margins and impact of higher TAC and other COGS (YouTube spend, etc). In all, our 2016 non-GAAP EPS falls by 7% to $33.40 (from $35.99). – Brian Nowak from Morgan Stanley.
We decrease our FY16 net revenue forecast by 30bps on higher Licensing & Other revenue, offset by a ~5% increase in our O&O TAC estimate. As we flow through the higher than expected TAC , adj. EPS for FY16 decreases by 160bps to $31.71 vs. our prior estimate of $32.24. Valuation: Our DCF-derived PT, which uses a 10.5% weighted average cost of capital and 3% terminal growth rate, remains unchanged at $920. – Stephen Ju from Credit Suisse AG
Our new Q2 2016 ests are net revs of $17.10b (from $17.21b); Adj. EBITDA $8.55b (from $8.68b), Adj. EPS $8.01 (from $8.50). Our new FY'16 ests are net revs of $71.8b (from $72.2b); Adj. EBITDA $35.3b (from $35.7b), Adj. EPS $33.38 (from $34.89). Valuation: Reiterate Buy Rating; $880 PT. – Eric Sheridan from UBS AG
We have modestly increased our 2016 and 2017 revenue and EBITDA estimates. As a result, our price target moves to $1,100 from $1,080. Our price target is based on a blended average of 25x EPS, 15x EBITDA, and 4% FCF yield on our 2016 and 2017 estimates for Core GOOG, and 2x revenue on our 2016 and 2017 estimates for Other Bets (Deutsche Bank’s revenue/adjusted EPS estimate for 2016 is $71.679 billion and $33.79 respectively). – Ross Sandler from Deutsche Bank
As it currently stands the consensus range is pretty wide and estimates on valuation vary quite significantly. On one end of the spectrum you have Ross Sandler assigning a $1,100 price target and at the low end Brian Nowak assigned a price target of $850 for Alphabet. The divergence of opinion on both valuation and sales/earnings estimates is due to lack of guidance, transition into investment year, and lack of visibility on “other bets” results.
You can only imagine how opinions vary on the buy side. However, I have yet to model my own financial assumptions on Alphabet, but plan to do so in a future article. That being the case, I still like the company due to its competitive positioning, improving operating cost leverage and better execution on mobile advertising.
On the other hand, Google results are wildly unpredictable, which makes it difficult to predict results. Even so, I think investors should capitalize on the recent drop. Therefore, I continue to reiterate my buy recommendation.