Google (NASDAQ:GOOG) (NASDAQ:GOOGL) enjoys a dominant position in the market because it continuous to innovate and diversify. It is either the leader or a dominant player in most of the markets it operates in. The company's management makes sure that its product portfolio is in line with needs of its users. Google's revenue mix is increasingly shifting towards more efficient sources like Play, which require little input but generate significant revenues. While YouTube is often tipped as the next multi-billion dollar opportunity for Google, one product that does not get as much attention as deserved is Google Play.
Within Google Play mobile games are the biggest source of revenue. Games accounted for 90% of Google Play app revenue in the first quarter, up from 80% in the same quarter last year. The proliferation of connected devices is ushering in the growth of mobile games and Google Play along with Apple's (NASDAQ:AAPL) App Store is the platform facilitating monetization, and for Google, this is the first tangible benefit of its ownership of Android.
Google Play - The Underappreciated Multi-Billion Dollar Opportunity
Google Play, which serves as a digital media store and offers games, music, magazines, books, movies, and television programs, over the last two years has grown from essentially zero to a level equal to YouTube in size and is expected to contribute $4.4 billion (CS estimates) in revenue in 2014. Similarly, Bank of America expects Google Play to add $9 billion in gross sales in 2014 ($1.5 billion net revenue). Bank of America further expects Google Play revenues to approach Apple's App Store revenues by 2016 and increase to $19 billion ($5.7 billion net revenue) by 2016.
While YouTube, which the company acquired back in 2006 for $1.65 billion, is often tipped as the next big growth engine for Google, Google Play has fast become equally important (if not more). Growth in Android smartphones and tablet installed base, a growing media content library, improving app availability, and improving payments and technology infrastructure have all contributed to Google Play's growth.
Potential to Ultimately Generate Higher Operating Profit and Free Cash Flow
Despite of its impressive revenue growth over the years, Google Play has not generated as much attention as it deserves. As Google Play's revenues are reported under Google's Licensing and Other revenue segment and the main drivers of its growth are overseas, these could the reasons of lack of attention. Despite of this lack of attention, the fact remains that Google Play revenues are growing at a faster rate than YouTube and as I mentioned earlier are predicted to reach the levels of Apple's App Store by 2016. Given the lower cost of its operations, Google Play also has the potential to ultimately generate higher operating profit and free cash flow.
Google takes 30% of all subscription payments from its publishers/ developers and only bears the costs related to credit card fees and pays a share of revenue to its telecom partners. Google Play has risen from nearly zero two years ago to a revenue run rate equal to YouTube, still Play receives disproportionate amount of attention from Google investors. While I do not mean to underestimate the importance of YouTube, which certainly is one of the next multi-billion dollars opportunities within Google, I'm only trying to emphasize that Google Play is an equally, if not more, important emerging business line for Google.
In a world where apps continue to grow in importance on mobile devices, Google Play is growing rapidly. Mobile users on average spend 86% of their time on apps and only 14% on mobile web. Google has made solid inroads into the app world with the launch of Play. The growth of Android has helped Google significantly. It's true, that developers have historically written apps for Apple before tackling the Android ecosystem. Apple no doubt has been bigger; it has a more engaged audience and the fact that it is easier to code has always worked in its favor. Google; however, has now started to close the gap. The growth of Android has made it much more important for app developers. Compared to a few years ago, now we hear less of an Apple-first mentality among app developers. Google Play is eventually benefiting from these changing trends and increasing importance of Android among developers. While, developers admit Android is still not as simple as developing for Apple, it has gotten easier and I expect with each software upgrade it will get easier.
App Marketing Also Resulting In Growth in App Revenue
An app can no longer be successful by simply putting it on Apple's App Store. 2007-2009 was golden days for apps when developers could monetize their apps by simply uploading it on Apple's App Store. Now for apps to be successful and maximum monetization they need to be available on both platforms. Since more than a million apps are available on both app stores, developers complain that their apps are often lost in a huge pool of apps and not meet their expectations.
This particular situation has led to emergence of a large-VC funded industry focused on technology to get these apps discovered in a huge pool of apps. These companies do not have exclusive association with either App store but they are helping accelerate the growth of app revenue using a mobile technology version of web advertising and analytics industry.
Apps stores have their limitations. They can only help consumers find apps based on ranks and key search words. Both App stores have more than a million apps each and in such a situation app developers cannot rely solely on users to find apps organically, as most users don't thoroughly research apps. Users are unlikely to find an app it doesn't rank in the top 10 or 20. This is why app marketing is emerging as an important industry. App marketing extends beyond the app stores and reaches consumers where they spend their time. App marketing influences consumers to return to app store to download a marketed app. According to Peter Hamilton, CEO of HasOffers,
"An app developer has hundreds of alternatives to promote an app: mobile ad networks, mobile content publishers, social networks and even television. These mobile specific channels use sophisticated analytics to optimize the spending on the channels that yield the best results, which can increase downloads, engagement and revenue."
Android has a dominant market share, which despite of low per capita spending by Android users, is driving significant app revenue. If this emerging app marketing and mobile advertising industry manages to increase per capita spending by Android users, Google's app revenue might not soon equal Apple's app revenues but might as well surpass it.
Similar to Facebook (NASDAQ:FB), Google is also expanding its services geographically in the wake of rising opportunities in the developing markets. While Facebook's plan is to continue to deepen its partnership with mobile operators, for Google a part of the plan is to offer "a comprehensive solution to address the mobile computing needs of those in emerging markets" via the Android One (a low-end smartphone reference platform). Given the already high penetration rates in the developed market, developing markets will be the key for future of Google.
Google offers the broadest set of products and services, with some of the highest barriers to entry. Google is either the leader or a dominant player in most of the markets it operates in. Despite of its huge size, the company has the potential to maintain double-digit earnings growth for many years to come. While YouTube is tipped as the next multi-billion dollars opportunity for Google, Google Play is growing much more rapidly and will ultimately contribute higher operating profit and free cash flow dollars given the lower cost to operate.
The proliferation of connected devices is ushering in the growth of mobile games and Google Play along with Apple's App Store is the platform facilitating monetization, and for Google, this is the first tangible benefit of its ownership of Android. While Apple has historically been the first choice of developers, Google's Android is increasingly gaining importance among developers. The past one year, particularly, has been phenomenal both for Google Play apps downloads and revenue. Google Play's quarterly app more than doubled from 1Q13 to 1Q14. This growth in Google Play downloads and revenue represents a significant opportunity for developers, which in turn would drive further revenues for Google.
Multi-billion dollar opportunities in Google Play and YouTube, dominant position in multiple markets, and double-digit earnings growth expectation combined with reasonable valuation, make Google a compelling investment opportunity.
Note: Comparison between Apple's App Store and Google Play does not mean I'm bearish on Apple or Apple's App Store's potential in fact I'm bullish on Apple but that's a discussion for another day.
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.