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Summary

  • Google reports 2Q14 results on Thursday.
  • I will place a particular focus on the state of Android ecosystem.
  • Remain positive on the stock and long-term growth of the Android ecosystem. Buy on weakness.

Google (GOOG, GOOGL) will report Q2 financial results this Thursday. Consensus expects EPS of $6.26 (+16% y/y) on $15.6b in revenue (+8.4% y/y). After an unexciting Q1, investors will be focusing on its core business of search and display ads.

While I expect GOOG's core business to remain steady as it takes market share away from traditional ad channels (i.e. TV), I am placing particular emphasis on the health of the Android ecosystem. In my view, Android will be GOOG's key to a mobile connected world, and winning the great ecosystem battle that is unfolding before us is critical for GOOG's future growth. The recent weak set of results from Samsung could indicate that Apple's (NASDAQ:AAPL) iOS is gaining ground, but I suspect that Samsung's weakness was due to competition from low and mid-end handset from emerging market OEMs rather than AAPL. I will be looking for confirmation signals in the upcoming result.

Gauging the status of the ecosystem battle

Samsung reported weaker than consensus result on strength of Korean Won, inventory and volume decline in the low/mid-end smartphone segment, which has become increasingly competitive as new entrants in emerging markets erode the large players' market share by offering competitive Android devices . (See my bearish note - Apple: The Party Is Over)

Interestingly, Apple-related stocks in Korea moved up assuming that Samsung's weakness was Apple's gain. In my view, GOOG stands to become the main beneficiary of the connected device revolution with its large install base, customizable software and multiple applications (i.e. Mobile devices, wearable, automotive), more so than iOS since the iOS ecosystem is still catered mostly to smartphones and tablets. I believe that Samsung's weakness is primarily driven by the competitive pressure from the low/mid-end segment, where pricing competition and the shift to LTE is causing an inventory glut, rather than iOS market share expansion. I note that AAPL is competing in a declining high-end segment that is facing slower replacement cycle, and taking market share away from Samsung is unlikely given AAPL's flattening innovation curve when compared with Samsung (see my Apple report for more details). I will be looking for the health of the Android ecosystem vs. the iOS in the upcoming earnings call.

New fronts have established in the ecosystem battle

GOOG's I/O conference has opened up multiple fronts in the ecosystem battle that is extending over all connected mobile devices, wearable, auto, TV and laptop. Although no surprises were announced, it was apparent that 1) GOOG wants to have a universal reach over all devices by leveraging Android, and potentially expand its presence in mobile communication and advanced robotics and 2) the progress will be evolutionary rather than revolutionary so investors should not expect near-term EPS impact from the advanced projects (i.e. wearable, driverless cars, robotics, home automation). That said, core business (display/video ads) will continue to be the driver while Android will be equally critical to GOOG's future growth as it is the company's only presence in the mobile devices space.

Conclusion

At 22x this year's P/E, GOOG trades in line with its large internet peers, which implies that the market is waiting to see further confirmation of the strength in both the core business and Android. Once confirmed, GOOG will likely trade above its peers given its above average growth profile and attractive pipeline across multiple platforms. I reiterate my bullish view on the stock and advise investors to buy on weakness post results.

Source: Google Q2 2014 Preview: Core Business, Android In Focus; Buy On Weakness