Does Google Have More Room To Run?

| About: Alphabet Inc. (GOOG)


Google reported strong quarterly results, with revenue and operating income coming in better than expected;

The news of the Chief Business Officer leaving came in as a disappointment;

Google is rapidly expanding itself through acquisitions and by entering into different partnerships.

The online search and advertisement behemoth Google (NASDAQ:GOOGL) (NASDAQ:GOOG) reported strong quarterly results, with revenue and operating income coming in better than expected. While the market responded positively to the quarterly numbers, the news of the Chief Business Officer leaving came in as a disappointment. Google reported accelerated revenue growth, with all three revenue segments reporting strong results. Moreover, the international business outperformed the U.S. in the quarter.

Google is rapidly expanding itself through acquisitions and by entering into different partnerships. Though there are reports of some pushback about capital intensity and pressure on margins as Google invests in new initiatives, its core advertising business remains very strong.

EPS Miss, Revenues Beat; Overall A Strong Quarter

The Mountain View, California based company's reported revenue grew 22% year-over-year to $15.96 billion. Consensus estimates were of $15.61 billion. The company's all three revenue segments reported strong results for the quarter. Moreover, the company's international business outperformed the U.S. and results from Europe, particularly the U.K, improved compared to the previous quarter. While the company is positive about YouTube growth potential and says that it's definitely a "powerful starting point for advertisers", it declined to comment on any specific YouTube revenues.

Despite reporting strong growth in revenues, Google's reported Q2 2014 operating EPS of $6.08 came in lower than consensus estimates of $6.24. The miss was largely driven by more than expected spending during the quarter. As a reminder, all these results exclude the $72 million loss from Motorola, which the company reported under its discontinued operations as it entered into an agreement with the Chinese company Lenovo (OTCPK:LNVGY) at the beginning of the year.

Not Without Its Challenges

Google's average cost per click [CPC] declined by almost 6% during the quarter, showing that the demand for web-based ads is flagging. However, the company continues to believe that, over time, mobile pricing will exceed desktop pricing and I would agree that this is very likely. As this dynamic closes and monetization efforts in non-U.S. markets take hold, it is likely that we will see CPCs no longer decline.

That is not to say that Google is without its challenges. The company continues to face strong competition from Facebook (NASDAQ:FB). Facebook's market share in the U.S. mobile ad market continues to rise. The social media giant's share of U.S. mobile ad revenues jumped from 9% in 2012 to 15.8% in 2013. Google's share, on the other hand, dropped from nearly 50% in 2012 to 41.5% in 2013.

Investing In Future

Google is also making huge capital investments to maintain its competitive edge in the long run. The company made significant capital expenditure of $2.65 billion during the quarter mostly on building data centers (key to growth in cloud services business), and buying real estate and procuring equipment.

Although the company reported strong growth in advertisement revenues, the internet advertisement goliath is working hard to keep its advertisement based business model in line with the mobile growth. The global ad spending growth is expected to double this year and the trend is increasingly shifting towards online and mobile advertisement.

The company also reported one of the biggest quarterly jumps in its head count in its history. Google during the second quarter hired nearly 2240 new employees, mostly in engineering and research. This is in direct contrast to software giant, Microsoft (NASDAQ:MSFT), which recently shrunk its headcount by an unprecedented 18,000 employees. Many of these sweeping layoffs are in the Nokia handset business, which Microsoft acquired earlier this year.

Continuing Its Spree of Acquisitions

The tech giant has been trying to strengthen itself in household for quite some time and despite of all the efforts to make its presence felt, the company hasn't made any significant progress in this regard yet. Google's Nest Labs (acquired earlier this year) recently made an announcement to acquire the home surveillance company Dropcam for $555 million. While Nest currently only offers thermostats and smoke alarms (monitored through smartphones), the company's recent move would increase its product portfolio into home security as well.

Dropcam offers user friendly Wi-Fi webcams and trackers and cloud based storage to its users and they can check that from anywhere on their connected cameras. Google's previous attempts such as Smart TV and Chromecast in the household market haven't yielded results up to the expectations. Google's new acquisition shows that it is struggling to establish a strong foothold over the increasingly growing market for web-connected household appliances. Despite its challenges, the company's this move would also give it access to more of the user data, which the company can use to sustain its already dominant position in the advertisement space.

In addition to making advancements in household, the company in order to not miss a significant leap forward in the hardware made a significant move in the health sector by entering an agreement with the drug maker Novartis (NYSE:NVS) to make "smartlens". Google entered the deal to bring its smart contact lenses into the healthcare market to be used for ocular medical purposes. Google's this technology would help the diabetic patients to maintain their glucose levels by monitoring their glucose levels using tears instead of them pinning themselves repeatedly during the day to get their glucose measurements through blood. Moreover, it would also help the people with presbyopia and would work for them like the autofocus function in the camera and they won't have to use different lenses for far and near sightedness. The details of the deal have not been disclosed yet.

The company also recently acquired a New York based music streaming company, Songza. Google's acquisition follows Apple's (NASDAQ:AAPL) high profile Beats Electronics acquisition for $3.0 billion. Amazon (NASDAQ:AMZN) also recently launched a music streaming service within its Prime subscription service. However, in terms of users, Songza with 5.5 million users is far behind the 40 million users of Apple's own iTunes Radio, Spotify's 40 million subscribers and Pandora's (NYSE:P) huge 70 million users.

Shuffling/Leaving of the Company's Key Executives

Lately many of Google's key positions in its major divisions, from YouTube to Android, are being reshuffled, which I believe could have both positive and negative effect on the company's future prospects and evolving business ambitions. Nikesh Arora is the most recent example of a key personnel change in Google. The longtime Chief Business Officer is leaving Google after a decade to join the Japanese tech conglomerate Softbank (OTCPK:SFTBY), as CEO of its Internet and Media operation and Vice Chairman of the overall company. Omid Kordestani, who has been advisor to the CEO and founders, will replace Arora.

Recently Google also announced that the former Ford (NYSE: F) CEO Alan Mulally would join the company's board and would serve its Audit Committee. This is an effective development given the company's expansion into the automated cars and plans for using Android in cars. Mulally joins Google after serving two successful stints at Ford and Boeing (NYSE:BA). Mulally has previously led Ford through the 2008 crisis which rocked the auto industry and has successfully propelled the company into the technology age.

Vic Gundotra, who introduced Google to social networking world and often termed as the father of Google+, is also leaving Google after eight years with the company. Similarly another key executive, Salar Kamangar, who has been serving as the head of YouTube since October 29, 2010 will leave YouTube to work in an unspecified role having to do with early-stages ventures. The longtime ad products head, Susan Wojcicki, will replace Kamangar as the new head of YouTube.

The reason for a string of personnel changes at Google is remains unclear; however, analysts are saying that it might be the result of the company's general desire to have a fresh perspective or a new pair of eyes on the key parts of its business as it pursues growth areas.


Despite of the bottom line miss, Google reported strong quarterly results. The company made huge investments in some potential forward looking projects. The news of Nikesh Arora leaving was a disappointment; however, overall it was a strong quarter. While focusing on its core product, Google search, the company continues to grow through acquisition and venture into new markets. I remain bullish on the stock. The company remains well positioned to continue to grow revenue and earnings at the current rate for an extended period of time. With forward price/earnings ratio of 19.3, there is compelling value in owning Google at current levels.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.