UPDATED 16:28 EDT / FEBRUARY 04 2019

CLOUD

Alphabet beats earnings forecast, but costs weigh on shares

Updated:

In almost as much of an anticlimax as Sunday’s Snoozer Bowl, Alphabet Inc. today again beat most expectations for its fourth quarter thanks to continued strength in its search and video advertising and investment gains. Only problem: Some higher expenses for spending on cloud engineers and data centers as well as YouTube content didn’t thrill investors.

The Google LLC parent said its profit hit $8.9 billion, or $12.77 a share, from a $3 billion loss a year ago thanks to tax law changes. Gross revenue rose 22 percent, or 23 percent before currency shifts, to $39.3 billion. Excluding traffic acquisition costs, or ad revenue-sharing payments to partner sites, revenue rose to $31.8 billion.

Analysts had expected a profit of $10.86 a share, or $11.02 adjusted for tax law changes. Gross revenue was expected to rise 20 percent, to $39.98 billion. Excluding traffic acquisition costs, the revenue consensus was $31.3 billion, up 21 percent.

For all that, investors apparently expected a little more operating income, which at $8.2 billion came in a bit short of the $8.6 billion consensus. Among the reasons for higher expenses that weighed on profits: higher content licensing costs for YouTube, more spending on data center operations and research and development, including more hiring of cloud engineers, and heavier marketing in the holiday season.

As a result, shares fell more than 3 percent in after-hours trading. Alphabet’s shares had risen 2 percent, to $1,141.42, in regular trading, putting them up about 8 percent on the year so far. Update: Shares actually closed up a little under 1 percent Tuesday, a bit more than the overall market.

On the cloud front

Google doesn’t report its cloud revenues, itself an indication that it continues to trail far behind market leader Amazon Web Services Inc. and Microsoft Corp. Chief Executive Sundar Pichai (pictured) has said only that it’s a billion-dollar-a-quarter business, and that was a year ago.

Today, Google said fourth-quarter “other revenues,” which is mostly cloud but also includes Google Play apps, smartphones and smart speakers, rose 31 percent, to $6.49 billion. That was just a little over the $6.43 billion analysts had expected.

Google Cloud closed out the year strong, with momentum across the board,” Pichai said on an earnings conference call. That included doubling the number of contracts and deals worth $1 million-and-up in 2018, as well as an uptick in deals of more than $100 million, Chief Financial Officer Ruth Porat added.

“We’re getting large wins,” he added. “That’s definitely something we want to focus on. Our product offerings are ready and differentiated, so want to invest in scale and go-to-market.”

Last week both of Google Cloud’s rivals reported continuing strong cloud revenue growth. Microsoft reported 76 percent growth for its Azure infrastructure-as-a-service business and 20 percent growth for its overall cloud business that also includes applications such as Dynamics 365 and Office 365. Amazon said its AWS revenues rose 45 percent, to $7.4 billion.

Google Cloud also drove higher expenses, mostly headcount, which rose from the third quarter by almost 4,400 people, to 98,771. Most of those were engineers and product managers, with cloud the biggest-growing segment, Porat said.

In addition, Google continues to spend big on cloud data centers, helping drive a 64 percent jump in fourth-quarter capital spending, to $7.1 billion. But Porat said capital spending’s growth rate would slow “meaningfully” in 2019.

Google’s cloud unit is laboring through a management transition as well. Google announced in November that unit CEO Diane Greene was leaving after three years at the helm, and in January she was replaced by former longtime Oracle Corp. executive Thomas Kurian. At the time, Dave Vellante, chief analyst at research firm Wikibon and co-CEO of SiliconANGLE Media Inc., said Kurian brings “the ability to prioritize, focus resources and move fast when things change.”

Indeed, some analysts are expecting bigger things, in particular a significant acquisition, though it’s not clear what company would change the landscape as much as, say, IBM Corp.’s $34 billion acquisition of Red Hat Inc. announced in October. Baird analyst Colin Sebastian, quoted by CNBC, said he expects a “meaningful acquisition” to “enhance enterprise sales/support functions and SaaS capabilities,” given that Alphabet’s $109 billion cash hoard allows Google Cloud to “go elephant hunting.” Pichai declined to elaborate today except to say that Google aims to get the “right fit” for any acquisition.

Ad competition

Google for now maintains its pole position atop a digital advertising duopoly with Facebook Inc., which reported better-than expected earnings last week on a 30 percent rise in revenues, virtually all from advertising. Thanks chiefly to its search ads as well ads on its YouTube video service, Google has 31.3 percent of the worldwide market to Facebook’s 20.5 percent, according to eMarketer.

But Google also faces more competition on the ad front. In particular, Amazon has been aggressively expanding its ad business, which is small but growing quickly.

“At Google’s massive scale, a slowdown in ad revenue growth is to be expected, particularly in the U.S., eMarketer Senior Forecasting Director Monica Peart said in an email. “But with talk of economic pressures on the horizon in the U.S., noticeable sluggishness in their fourth-quarter performance could warn of more dramatic slowdowns in the digital advertising market, which had been relatively insulated while the ad giant enjoyed strong double-digit growth rates.”

Another Google segment of wide interest, called “Other Bets,” that includes such companies like as health venture Verily and self-driving firm Waymo, rose 18 percent, to $154 million, well short of the $187.4 million analysts were looking for. Operating loss for the unit was $1.3 billion, way up from $748 million a year ago.

Although those losses are nothing new, they could be concerning investors more, as what’s next beyond advertising is weighing more heavily on some.

“The bottom line is that GOOG remains a truly remarkable rev growth story, but visibility into the key drivers is very limited,” Macquarie Capital (USA) Inc. analyst Ben Schachter wrote in a note to clients. “Eventually, advertising growth will slow, and we worry that Other revs will not make up for the deceleration and opex will continue to hit margins. With almost 100,000 employees, GOOG has a lot of opportunities ahead. We wish we could see more clearly how those translate into operating profit.”

Photo: Robert Hof/SiliconANGLE

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