Tuesday, October 21, 2014

Google Inc. 3Q14 Earnings: Continued Growth Despite Earnings Miss

Google Inc. posted revenues of $16.53 B and non-GAAP EPS of 6.35 dollars per share for Q3 of 2014. Consensus was at $6.53 for EPS and $17.2B for revenue. Revenues were up 20% Y/Y and 4% Q/Q. Geographical growths were strong, with Y/Y revenues up 15% in the US, 17% in the UK, and 26% outside those areas.  

Paid clicks were up 17% Y/Y and 2% Q/Q, a slowdown from 25% in Q2, and cost per click was down 2% Y/Y and flat Q/Q. Sales chief Omid Kordestani attributes this to a normal fluctuation that happens from time to time and is actually the lowest CPC decline seen by Google in the last seven quarters. The cost per click metric is an indicator showing pressure from low smartphone ad prices is abating.

Google sites revenues were up 20% Y/Y, attributed to mobile search, and came in at $11.1 BB. Network revenues were up 9% Y/Y coming in at $3.4 B due to growth in the AdMob and the Ad Exchange business, but was lower than expected. Other revenue increased by 50%, fueled by Google Play and ad licensing, to $1.8B. Free cash flow is at an impressive $3.6 billion, up 28% Y/Y.

Heavy spending was the driver behind the lower than expected EPS with R&D spending up 46%, S&M up 28%, and G&A up 20%. CFO Patrick Pichette stated “it’s the time of year when we do equity refresh”, in regards to heavy opex growth and human resource spending. He says that this is a unique quarter because of this. Traffic acquisition costs (TAC), came in at $3.3 BB, representing 23% of ad revenues. The stock lowered in after-hours trading by 1.25% under the $520 range and dropped below $510 Friday, but has made a good gain in the next week back at $520.

Google’s core business growth has slowed across the board while profitability took a hit due to opex spending. A main factor is that international growth has not been up to par. However the investment seen this quarter should bode well for the future. The long term growth has been supported in areas such as robotics, Android, automation, and internet. There are some exciting upcoming technologies such as the Android One low-cost smartphones, a mobile messaging platform, and Google Fiber Optic. Shares didn't drop too much despite the miss; however the drop off over the month is a cause for concern. Shares dropped nearly 70 points in the past month for a wide array of reasons from competing products to legal battles. This is quite a fluctuation for Google, but a rebound should be in the works. Some investors may be panicking, especially with increased competition in mobile advertising and mobile phones, but the drop is overstated.

Solid growth and strong free cash flow are major contributors to the company’s positive outlook. However consistent estimate misses by Google has become an issue. There has been a growth in these misses over the last quarters. In the last 12 quarters, Google has missed nearly 92% of the time on the top or bottom line. Margins have also decreased, bringing the risk of the business flattening out. We expect margins to increase in the future as expenses drop. We still believe Google is undervalued with strong revenue growth around 20% each quarter and a strong investment into the future over the past months. Expenses should come back to normal levels, but a less than stellar quarter has us scale back our price target. We recommend a hold on the company with a price target around 670.

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