Will Alphabet Report Improved Profitability In Its Q4 2015 Earnings?

  •  Alphabet will report Q4 2015 earnings on 1st February 2016 after market close.
  • Alphabet is expected to report upbeat earnings as it continues cutting costs and improving profitability.
  • This should keep Alphabet stock hot in the near-term and mid-term.

Alphabet Inc-C (NASDAQ:GOOG) will report fourth quarter 2015 earnings on 1st February 2016 after markets close. The consensus is for Alphabet to report EPS of $8.10 and revenue of $20.72B.

Alphabet stock enjoyed a meteoric rise in 2015, finishing the year 40%+ up and in the process overtaking Apple (NASDAQ:AAPL) as the most valuable company in terms of enterprise value, and now speculations are on about whether it will overtake Apple in terms of market cap. There are two reasons why Alphabet shares performed so well in 2015: the re-organization of the company into a holding company Alphabet that separates the company’s core ad-business from its non-core projects, and the company’s much-improved bottom line courtesy of cost-cutting among other things.

Alphabet said that the re-organization will take place in phases. The fourth quarter 2015 earnings call will be the first time the company will fully separate its core ad business from its non-core businesses which it will report under ‘‘Other Bets.’’

Alphabet's Cost Discipline

Investors have for long been calling for Google to exercise some measure of cost discipline regarding its moonshot projects including driverless cars, Nest, Google Fiber, and others. Google has been investing in its moonshot projects for years with little to show for it.

Google’s moonshot projects lost the company ~$5B-$6B in 2015 alone. As businesses such as Google Fiber become profitable, however, Alphabet should be able to significantly pare back these losses or even wipe them out altogether. Google Fiber in particular has been well received and could become a $1B business during the current year.

Investors have been concerned about the company’s other swelling costs, particularly traffic acquisition costs, or TAC, which have been eating away at the Google’s margins and bottom line. Google’s TAC reached a high of 25% of revenue in 2013 as the company had to pay companies such as Apple and Mozilla huge sums of money for Google to become the default search engine in their respective browsers. Google has been paying well in excess of $1B to Apple to become the default search engine for iOS’ Spotlight Search as well as Mobile Safari.

But Apple dropped Google for Spotlight Search in late 2014 in favor of Microsoft’s Bing Search while Mozilla ditched Google and instead partnered with Yahoo (NASDAQ:YHOO) around the same time. As a result, Google’s TAC fell from 25% of revenue to around 21% during the last quarter. A recent court testimony by Oracle’s lawyer revealed that Google and Apple had a revenue sharing deal for Spotlight Search, with Google receiving 34% of revenues generated, up from 25% a couple of years ago. The same testimony revealed that Google had earned $34B in revenue and $22B in profits from its Android OS since 2008, which suggests that current estimates for Google Play could be substantially lower than the actual figures.

Google’s CPC rates have been falling over the years as the company is increasingly becoming a mobile company. Mobile CPC rates are typically lower than desktop CPC rates. The increasing contribution by YouTube to Google’s top line has also been dragging down overall CPC rates.

But Google intends to start using better targeting to improve its CPC rates. For instance, Google plans to start using user data from Google sites for YouTube ads instead of its current practice of only using data from Google’s DoubleClick partners. Facebook (NASDAQ:FB) is one company that has been able to improve its CPC rates even as ad impressions continue falling. FB ad impressions fell 21% Y/Y during the third quarter but aggregate clicks rose 30% mainly due to a huge 64% increase in click-through rates as a result of better targeting. CPC rates improved 10% Y/Y during the quarter. Google’s aggregate CPC fell 11% Y/Y during the third quarter, and an improvement in this metric could contribute significantly to the company’s revenue growth.

YouTube Could Soon be Profitable

Google recently introduced YouTube Red, an ad-free subscription service for YouTube, in October 2015. Current indications are that the service has been well received since the app is already ranked as one of the top-ten grossing apps in the U.S. YouTube Red should give a nice boost to YouTube’s bottom line. YouTube is yet to become profitable for Google despite grossing more than $4B in revenue in 2014 and ~ $5.5B in 2015. YouTube’s Red contribution to Google’s fourth quarter earnings, however, will be minimal.

Google is counting on YouTube and Google Play to drive its next phase of growth, and both platforms appear to be doing well.

Google Gets off Lightly

Investors have been worried that Google might be slapped with a hefty fine and taxes by the U.K. government and other EU countries if found guilty of artificially shifting its revenue to low-tax countries such as Ireland in a bid to cut down on its tax bill. After all, American banks frequently have to pay billions of dollars for fines whenever found guilty of financial impropriety.

But recent investigations cleared Google and found that it only has to pay £130M in back taxes to the U.K government, much less than was feared. Many U.K. tax experts have been up in arms over the ruling calling it a ‘‘sweetheart deal’’ since Google got off too lightly. Google investors, however, couldn’t be happier with the ruling.

It’s not clear if Google will take the charge during the current quarter (Q1) or had allocated it to the fourth quarter. Either way its effect on Alphabet’s bottom line should be minimal.

Investor Takeaway

Alphabet appears to be firing on all cylinders, and this should reflect in its upcoming earnings call. Alphabet still has numerous opportunities to cut costs and improve profitability, and this should keep the Alphabet stock hot in 2016.

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