Alphabet (GOOG/GOOGL) reported better than expected 3Q17 results. Sales were up 24% compared to 3Q16, accelerating from 21% year-over-year growth last quarter. Earnings per share were almost 15% above expectations, partially boosted by a favorable tax rate. Mobile search advertising, YouTube, and cloud computing each contributed to the strong results.
GOOG grew advertising revenue by 21% demonstrating continued success on the shift from desktop to mobile search as the primary platform. The cost per click (the price an advertiser pays for a search ad) for mobile ads is substantially lower than the cost for desktop ads, which has been a headwind for GOOG throughout this transition. However, that headwind may be nearing an inflection point as the overall cost per click increased from last quarter after a sustained period of decline.
YouTube remains a strong driver of growth at GOOG, with over 1.5 billion users watching an average of 60 minutes per day on mobile alone. Aside from desktop and mobile viewers, watch time in the living room is now over 100 million hours per day, up 70% compared to last year. These staggering figures help explain why even successful streaming companies such as Netflix (NFLX) have self-described “YouTube envy.”
Cloud computing is another area of focus and investment for growth at GOOG. The company noted that a substantial portion of recent hires were joining their cloud division. As GOOG continues to invest in improving cloud products and services, Northlake expects market share gains to follow. Progress is already becoming apparent as GOOG highlighted new deals with large companies such as Cisco (CSCO).
Artificial intelligence and machine learning are important building blocks of every aspect of future plans at GOOG. The company is working diligently to incorporate these technologies into everything they do to continuously improve the user experience. While these investments in new technology are not cheap, Northlake believes they provide a substantial competitive advantage.
One concern from the quarter is that GOOG increased the costs they paid to acquire search traffic. When asked about the increase, the company noted that they have been making similar deals for decades, and that it was simply a cost of doing business. Management also noted they will sacrifice margin for operating profit growth in dollars. It is clear that the first priority for allocating capital at GOOG is investing in sustained growth, as evidenced by the continued 20%+ growth over recent years. Investments in Other Bets such as self-driving cars at Waymo are also an important part of the long term growth strategy at GOOG.
Given the consistency and recent acceleration of growth at GOOG, Northlake believes the stock is fairly priced around 22x next year’s earnings after adjusting for net cash per share. As investors begin to look toward 2018 and beyond, Northlake believes GOOG can move toward and beyond $1,100.
GOOG/GOOGL is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. GOOG/GOOGL is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.