Google's Gains Backed by Core Search Operations
Google's paid clicks are likely growing faster than the company's number of users, says Morningstar analyst Rick Summer.
Market Update
Google (GOOG) announced third-quarter earnings Thursday showing impressive strength in its core search business that was above our expectations, more than offsetting the lack of growth in the business of placing ads on third-party websites. We plan to revise our forecast to account for stronger near-term revenue growth.
Additionally, as the core search business is more profitable than Google's other segments, we will probably increase our fair value estimate by approximately 10%. Our wide moat rating remains the same.
Quarterly revenue from Google sites (advertising revenue from Google-owned properties such as Google.com and YouTube) grew 20% on an ex-TAC (excluding traffic acquisition costs) basis versus 2012, while the online ad network (for ads placed on third-party websites) grew only 1%. Supporting this growth, paid clicks grew 26% versus 2012 while costs per click declined 8%. While we believe ad pricing reflects a heavier mix of mobile advertising, the strong growth in paid clicks is equally important to our investment thesis.
We believe Google's strong technical assets in advertising technology have supported its ability to improve the relevance of its advertising, resulting in a higher number of people clicking on those ads. In fact, we estimate that Google's paid clicks are growing faster than the company's number of users. While this outperformance cannot continue forever, we believe it is likely to persist over the next couple of years.
In terms of profitability, Motorola continues to be a drag on overall results. The handset division posted a $317 million operating loss as it continues to struggle. We are underwhelmed by the progress of this division and question the synergies that management claims with Google's core advertising business.
Google's GAAP operating profit was $3.4 billion, or 23% of consolidated revenue. Although operating margins should expand as Motorola eventually reverses losses, we believe investors should focus on the core business and hope that management does not overinvest in this business. In our view, Motorola is unlikely to drive excess returns on capital.
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