Why Google Needs to Tighten Up

| About: Alphabet Inc. (GOOG)

Google’s (NASDAQ:GOOG) Q4 earnings, reported yesterday, exceeded market expectations. Revenue of $5.7 billion grew 18% over the year and 4% sequentially. EPS of $5.10 represented 15% annual growth and 4% quarterly growth. The market was expecting revenue of $5.6 billion and EPS of $4.95. Profits, however, fell year over year. Net income for the three months ended in December fell sharply to $382 million, or $1.21 a share, from $1.2 billion, or $3.79 a share, in the same period a year earlier.

Google.com’s revenue grew 22% over the year to $3.8 billion, and AdSense was up 4% year-over-year to $1.7 billion. Global aggregate paid-click recorded growth of 18% over the year and 10% over the quarter.

US revenues rose 13% annually to $2.8 billion. International revenue contributed 50% of total revenue, though there was softness in the UK markets, which were down 1% over the year. The rest of Europe was driven by strong growth in Germany, France and the Netherlands.

Continuing its efforts to monetize YouTube, Google introduced sponsored videos and new video contests on the site this quarter, including a contest to win a trip to the Davos World Economic Forum and Project: Report, a journalism contest produced in partnership with the Pulitzer Center.

During the year, Google improved its search experience through more than 350 innovations. The biggest addition was the increased size of their index; they tripled the number of queries that trigger different types of results across images, videos, news, blogs, websites, and of course, books, but still abstained on vertical search.

They are extending their monetization strategies to the mobile arena. As more people are using mobile phones to search the web, Google launched a voice search feature for iPhones. They had partnered with T-Mobile for the launch of the first Android phone in October and were “quite pleased with the market’s response.”

Their AOL (NYSE:TWX) stake, however, is giving them trouble. Google had acquired a 5% stake in AOL for $1 billion three years ago and had to record a $726 million hit in the quarter against that purchase price. The Clearwire acquisition is facing similar writeoffs.

In a move to lift employee morale, Google announced that existing options could be exchanged for lower vesting prices. Further, the new options will have 12 months added to their original vesting schedules to help increase employee retention.

The stock meanwhile continued to slip, by 3% to $306.50, after having significantly recovered from a 3-year low of $247.30 in November 2008, right after the announcement. This morning, however, the shares are up to $325.

The investor optimism is partially based on the fact that advertising budget continues to shift from offline to online, especially because of the significantly better measurability of the online channels, and also because consumers and businesses spend increasingly more time on the computer.

Google’s profitability hit, however, raises some concerns. The company has a lot of redundant people who contribute nothing to its business, doing experimental projects. While during the days of grandiose profitability, investors did not question this allocation of resources, with declining profits, they will.

There are also other issues to watch in the profitability equation, including AdWords revenues that have mistargeting, or fraudulent dynamics. While right now, Google is a black box, as technology evolves to provide better independent auditing capabilities, these kinds of algorithm misbehavior is going to become transparent.

Long term, Google’s loosy-goosy culture will need tightening up!