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Google Ends the Year Well

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Google Inc reported fourth-quarter earnings of $8.68, exceeding the Zacks Consensus Estimate by 7 cents. Shares appreciated 5.0% in response.

Google’s superior algorithms have consistently attracted more users and generated better conversions.  Therefore, the company has generated much stronger revenues than competing search engines from Yahoo and Microsoft (MSFT - Free Report) . While margins have thus far been far superior, the scenario is changing now because of the addition of Motorola.


Google’s gross revenue touched a record $14.4 billion, representing sequential and year-over-year increases of 2.3% and 36.2%, respectively. Excluding the $1.5 billion contribution from Motorola, revenue was up 21.9% from the year-ago quarter.

Google is very strongly positioned in the mobile segment, where smartphones and tablets from Apple (AAPL - Free Report) , Samsung and others have been making strong headway. This dominant position has enabled Google to generate very strong mobile revenue growth. In fact, the company’s position in mobile looks better than it was on traditional computers, which says something about its strategic planning and execution.

Additionally, Google continues to benefit from the secular shift in advertising spending from offline to online properties, increasing contribution from medium and small-sized advertisers, success of the DoubleClick ad exchange, improving search algorithms and better ad quality.

Revenues from both Google-owned and partner sites continued to grow double-digits on a year-over-year basis (they have grown double-digits each quarter over the last few years). Google websites accounted for around 60% of quarterly revenue, while partner sites accounted for another 24%. Total advertising revenue was up 11.2% sequentially and 18.7% year over year.

Total traffic acquisition cost, or TAC (the portion of revenue shared with Google’s partners and amounts paid to distribution partners and others who direct traffic to the Google website) was up 11.2% sequentially and 3.1% from the year-ago quarter. However, we do not consider this a reason for concern since the traffic acquisition cost as a percentage of total advertising revenue was consistent sequentially and down 384 bps from the year-ago quarter.

While both items in TAC went up in the last quarter, distribution payouts were up more significantly. Net advertising revenue, excluding TAC was up 11.2% sequentially and 25.2% year over year.

Other revenue accounted for 6% of the total in the last quarter, up 24.5% sequentially and 102.2% from the Dec 2011 quarter.

The Hardware and Other segment (Motorola) accounted for more than 10% of revenue in the last quarter. The 14.8% sequential decline was because of the sale of the home business, which the company treated as discontinued operations in the last quarter.

Total revenue excluding total traffic acquisition costs came in at $11.3 billion, 8.3% lower than our estimated $12.4 billion.

The U.S. generated around 46% of Google standalone revenue, up 10.6% sequentially and up 20.3% from a year ago. The U.K., with a 10% revenue share was up 7.3% sequentially and 22.7% from last year. Other international markets accounted for the remaining 44% of revenue, representing sequential and year-over-year increases of 14.6% and 23.5%, respectively.

Motorola derives more than half its revenue from the U.S. and has a limited presence in the U.K. Both the U.S. and other international markets were impacted by the decline in Motorola revenue in the last quarter.


The gross margin of 56.9% declined 811 bps from the year-ago quarter, but expanded 339 bps on a sequential basis. The decline in Motorola revenue share resulted in a positive mix, which helped the sequential comparison in the last quarter. However, the absence of any Motorola revenue in the year-ago quarter had a negative impact on the year-over-year comparison.

The standalone Google gross margin was 61.5% (up 6 bps sequentially) compared to standalone Motorola’s 17.4% (down 47 bps sequentially). The advertising gross margin was the combined effect of revenue growth, a 9% sequential (24% year-over-year) increase in the number of paid clicks, and a 2% sequential increase (6% year-over-year decline) in the cost per click.

The number of paid clicks and cost per click appears significant, as they are indicative of higher volumes coming at lower prices. The mobile and emerging markets businesses are growing strongly and distribution costs are increasing, which could be the reasons.

Other costs, associated with data center operation, amortization of intangible assets, content acquisition, credit card processing and manufacturing and inventory-related costs increased significantly as a percentage of sales, which also negatively impacted the gross margin in the last quarter.

Operating expenses of $4.81 billion were flat sequentially and up 42.6% from the Dec quarter of 2011. The operating margin was 23.5%, again impacted by the higher hardware-related costs. All except G&A costs declined sequentially as a percentage of sales although all costs were up from the year-ago quarter.

Non-operating gains were $152 million, up from $63 million in the previous quarter and a loss of $18 million in the Dec 2011 quarter.

Google reported net income of $2.9 billion, or 20.2% of sales, compared to $2.2 billion, or 15.4% of sales in the Sep 2012 quarter and $2.7 billion, or 25.6% of sales in the year-ago quarter. GAAP earnings of $8.62 a share were up from $8.53 in the previous quarter and $8.22 in the Dec quarter of 2011. There were no special items in the previous and year-ago quarters.

Balance Sheet

Google has a solid balance sheet, with cash and short term investments of nearly $48.1 billion, up $2.4 billion during the quarter. The company generated around $4.7 billion from operations in the last quarter and spent $951 million on capex, netting a free cash flow of $3.0 billion.

Our Take

Google reported solid fourth-quarter results that were stronger than the Zacks Consensus Estimate indicated. The strength was broad-based across Google and partner sites and driven by growth across geographies. Motorola remains a drag, although management has disposed of some of the business and has a specific strategy with respect to the rest. Google’s growth strategies are clearly paying off despite the deterioration in pricing.

Google generates revenue primarily from the sale of advertising space on its online properties. It has therefore focused on protecting and growing its position in the search market through continued innovation and quality improvements. This focus has ensured that it remains the dominant player in search across desktop and mobile platforms.

Google’s Android OS has gone a long way toward cementing its position in the mobile segment. Google has also made acquisitions over time that have augmented its in-house capabilities.

Despite the many legal entanglements related to competitive matters, Google’s initiatives to drive growth and superb execution to date have kept the shares buoyant. As a result, its share price has appreciated more than 20% over the past year.

Google shares therefore carry a Zacks Rank #2 (Buy).

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