By Jeff Reeves
Google Inc. reported third-quarter earnings Thursday with strong results that topped expectations on increased volume for its core advertising business. On Friday, its shares topped $1,000 for the first time. And while investors are obviously impressed, many are taking the wrong message away from the results.
There are still serious risks as the broader online advertising business remains squeezed by "cost per click" metrics. In fact, CPC numbers dropped 8% compared with the last quarter and 4% year over year.
And while a beat on both revenue and earnings is great, it's important to remember that revenue growth is consistently much stronger than profit growth amid weak margins.
So if you're going to be bullish on Google (GOOG) , don't read too much into the earnings this time around. Sure, it's good to see revenue up 22% year-over-year across the universe of Google sites, but that kind of growth will eventually run up against a ceiling as the numbers become so large that similar 20% increases will be much more difficult to achieve in a year or so -- and even if they are, the profits won't be there anyway thanks to declining margins.
That doesn't mean I'm bearish on Google by any stretch of the imagination, of course. I recommended the stock in May in this column and continue to see strong upside for shares.
But to me, the long-term bullish case for Google is best described by looking beyond third-quarter earnings -- and frankly, looking beyond the legacy ads business altogether.
Google's 'other' revenue
This is my favorite Google number to watch. When you look back at the last four annual reports, the "other revenues" segment is soaring -- and last year, it proved it's becoming an even bigger piece of the pie.
--"Other" revenue in 2009: $762 million, or 3.2% of $23.65 billion in total revenue
--"Other" revenue in 2010: $1.09 billion, or 3.7% of $29.32 billion in total revenue
--"Other" revenue in 2011: $1.37 billion, or 3.6% of $37.9 billion in total revenue
--"Other" revenue in 2012: $2.35 billion, or 4.7% of $50.18 billion in total revenue
And by the way, those 2012 numbers don't include the Motorola Mobility hardware division, which is broken out on its own line in documents. Motorola revenue totaled an additional $4.14 billion on top of the other "other" revenue -- so if you want to look at advertising vs. not advertising revenue by baking this in, total non-ad dollars were $6.49 billion last year -- or 12.9% of total revenue.
That's very substantial.
And now consider that in the latest quarter, "other" revenue grew a stunning 85% compared with the year-ago period to $1.23 billion. That's half of the entire total in calendar 2012. And just two short years ago, the "other" revenue total for third quarter 2011 was just $385 million -- less than one-third of third quarter 2013's numbers.
Year-to-date Google has tallied $3.3 billion in "other" revenue and $3.2 billion in Motorola sales. Total revenue across the first three quarters of the year is about $43 billion so combined these groups are now 15% of total revenue year-to-date.
And as you can see, growing fast.
-Jeff Reeves; 415-439-6400; AskNewswires@dowjones.com
Google looks for total Internet domination
Of course, the same criticism about margin trouble must be leveled at this fast-growing revenue segment, too. Motorola did generate $1.18 billion in revenue on the quarter, 8% of the third quarter's total, but wound up posting a substantial $248 million operating loss as Google burned cash on the Moto X launch.
And while the tech giant's Google Fiber Internet access is a cult sensation in Kansas City, the roll-out in Austin, Texas, could be a big cash burn now that AT&T (T) has announced a competitor that will launch in the city, too -- and actually get there first. The capital expense of building a fiber optics communication network is daunting enough without a big telecom pushing down pricing and margins in the market.
But these are not vanity projects. Google Chief Executive Larry Page made great pains in 2011 to state that it is putting "more wood behind fewer arrows," and the cash burn now could pay off big time down the road, as Google looks to get its fingers in every piece of the Internet pie in the very near future.
This includes device hardware through Motorola, software via its Android OS among other things and Internet access with Google Fiber.
This includes a mega-push into local with reviews for restaurants via recently acquired Zagat, directions to the restaurant via Google Maps and coupons for a free appetizer via Google Offers.
Oh and while you're at that new restaurant, why not pick up the check with Google Wallet mobile payment solutions?
This is what Amazon (AMZN) has done to retail by selling clothes and downloadable movies and diapers and even groceries. And while the ad biz is undeniably the biggest driver of growth in the near term, that's just one piece of the entire Internet experience that Google is clearly aspiring to control.
These are all admittedly aspirational projects that are not hitting the bottom line. As MarketWatch's Therese Poletti pointed out after the earnings, "Google's ad-heavy business has little in common with many of the key drivers for other big tech firms," and that will likely remain true for some time.
But if this ramp-up of Google's "other" revenue segment continues, it could quickly distance itself not just from conventional hardware and software companies but also from advertising-focused Internet stocks like Yahoo (YHOO) and Facebook (FB) , too.
So don't place too much stock in Google's earnings as the long-term bull case for the stock. While ads are important now, the numbers aren't as impressive as some think they are.
More importantly, in a few years, the ad numbers may not be the most important metric to watch.
-Jeff Reeves; 415-439-6400; AskNewswires@dowjones.com
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(END) Dow Jones Newswires
10-18-13 1140ETCopyright (c) 2013 Dow Jones & Company, Inc.
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