Sell-Side Reaction to Google Earnings -- Mark Mahaney (GOOG)

| About: Alphabet Inc. (GOOG)
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Mark Mahaney Smith Barney CitigroupCitigroup analyst Mark Mahaney on Google Inc's (GOOG) earnings (see also the Google conference call transcript), from his note yesterday to clients:

GOOG: Strong Broad-Based Growth, We're Materially More Positive

• Google reported a Strong Beat quarter -- $1,531MM rev, $1,002MM EBITDA, and $2.29 non-GAAP EPS vs. Street at $1,444MM, $888MM, and $1.97 respectively. EPS growth was a very robust 83% Y/Y.

• Fundamentals were strong -- Adjusting for FX, net revenue growth was 98% Y/Y vs. 99% in December (so, essentially no deceleration). As expected, EBITDA margin declined 340 bps Y/Y to 65.5%.

• Estimates increase -- '06 EPS from $11.22 to $11.96; PT from $490 to $550.

Google reported March quarter net revenue of $1,531MM, up 93% Y/Y (98% Y/Y excluding FX) -- $57MM higher than our estimate -- EBITDA of $1,002MM -- $86MM higher than our estimate -- and non-GAAP EPS of $2.29 -- $0.31 higher than our estimate.

Where did all that revenue upside come from? On a geographic basis, the greater than expected strength was almost all international. We had expected $870MM gross international revenue (up 77% Y/Y), and GOOG printed $947MM (up 93%Y/Y). Adjusting for FX, International gross revenue growth actually accelerated – from 105% Y/Y growth in December to 106% in March. Peel back the onion, and it appears that GOOG likely took share in almost every international market. Management even claimed that it might have taken share in the Chinese and Japanese markets – where conventional wisdom has them in deep 2nd place and drifting. Management also specifically stated that the UK finance and travel verticals, which were weak in the December quarter, snapped back in the March quarter. Seems in hindsight that the international weakness in the December quarter was likely a red herring. And it’s clear in hindsight that the company’s confident comments at its March 2nd Analyst Day about international strength were legit. All in, international as a % of gross revenue reached a record high 42%. And given that likely well over 50% of Google’s queries come from outside the U.S., we believe there’s still a lot more growth to come from international markets.

On a vertical basis, the company singled out the retail, technology, and finance verticals in North America as particular areas of strength. On a product basis, the company said that locally targeted ads have now become a meaningful contributor to revenue. Finally, Google almost mentioned continued strong growth in its advertiser base.

In terms of the formal revenue breakdown, there was broad-based upside to both our Google Websites and our Google NetworkWebsites revenue estimates, as detailed below. We would point out that TAC (traffic acquisition costs) declined to 77.8% from 78.8% in the December quarter, and that the company said there were seeing minimal pressure on this key line.

Did Google’s fundamentals improve? Yes and no. Y/Y net revenue growth jut barely decelerated to 98% from 99% in December (adjusting for FX). Given how high the growth rates are, we believe this accomplishment is very impressive. EBITDAmargins contracted 340 bps Y/Y but expanded 240 bps Q/Q to 65.5%.

Were fundamentals better than the Street expected? Yes. Net revenue of $1,531MM, EBITDA of $1,002MM and non-GAAP EPS of $2.29 came in far stronger than the Street estimates of $1,444MM, $888MM and $1.97 respectively.

Did the company raise guidance relative to the Street? No guidance from the company, as per its standard operating procedure. We do expect Street estimates to go up given Google’s out performance during the quarter.