Google has rare stumble

The company is so ubiquitous that its name is a verb. But being part of the lexicon isn’t a pathway to riches. What’s most interesting about Google’s earnings this quarter is the business media’s portrayal of a 19 percent rise in revenue as a misstep.

Rolfe Winkler and Alistair Barr wrote for the Wall Street Journal that increased costs caused the drop in profit:

Fast-rising expenses eroded Google Inc.’s first-quarter profits, disappointing investors and sending Google shares lower in after-hours trading.

The Internet-search giant said revenue for the quarter rose 19% to $15.4 billion from $13 billion a year earlier, excluding the Motorola Mobility business Google plans to sell to China’s Lenovo Group Ltd. Analysts had projected revenue of $15.5 billion on that basis, according to S&P Capital IQ.

But expenses grew faster—at 23%. As a result, Google’s net income increased 3% to $3.65 billion, or $5.33 a share, from $3.53 billion, or $5.24 a share. The figures were adjusted for the pending Motorola sale and a 2-for-1 stock split.

Excluding stock-based compensation and other items, Google said earnings were $6.27 a share; on that basis, analysts had predicted $6.41 a share.

“The top line was pretty good, but the margin compression probably disappointed the market,” said Brian Wieser, an analyst at Pivotal Research Group. “The margin erosion trend seems to be well in place.”

The New York Times headline said earnings “disappoint” in a story by David Streitfeld, which pointed out Google is making acquisitions in order to post growth — at some point:

Its core digital advertising business is so dominant that analysts are questioning just how much it can continue to grow. So Google is unleashing its vast cash hoard on robotics, artificial intelligence, smart thermostats and, just this week, high-altitude drone satellites.

The only thing all these acquisitions have in common is a focus on the future — often, the distant future.

The risk in thinking about what will be big in 2050, however, is that you can lose sight of 2014.

Google’s first-quarter earnings report, released after the market closed on Wednesday, surprised Wall Street. The company has traditionally gushed profits without breaking a sweat. Now it takes more of an effort.

One big reason was a problem of several years’ standing: Internet users are migrating to mobile devices, but ads on phones and tablets still do not have the familiarity and appeal they do on bigger computers. And they are not as profitable for Google. Google’s ad volume jumped 26 percent in the quarter, which sounds good but is less than expected, while the amount advertisers pay dropped 9 percent, which sounds bad and is.

The CNET story by Seth Rosenblatt led with the fact investors didn’t like the news either:

Google’s shares fell sharply in after-hours trading Wednesday following first-quarter earnings and sales that missed Wall Street’s expectations, thanks in part to its continued acquisition binge and the ongoing shift in ad revenue from desktop to mobile.

The stock was down 5.85 percent to $524 per share immediately after the markets closed.

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Colin Gillis, senior technology analyst at BGC Financial, said “a little [investor] pullback is healthy.”

“[Cost-per-click on] mobile’s a major problem. People have had a decade to optimize their [desktop] sites,” he said. Even though mobile ad revenue is rising, it’s not rising as fast as desktop is shrinking.

Kevin Shalvey wrote for Investor’s Business Daily that Google’s fall was based on lower pay ad clicks:

Google since mid-2011 has focused on building mobile-ad technology, in part to increase revenue from users in emerging countries where smartphones are used more widely than traditional desktops.

But worldwide paid clicks on ads grew just 26% in Q1, down from 31% growth in the three months prior. Analysts expected 29% growth, says Seyrafi.

Advertisers still aren’t willing to pay as much for a click on a mobile ad. Google’s overall cost-per-click, or CPC, rate slipped 9% from a year earlier, although it remained unchanged from Q4.

“I believe, in the medium to near term, mobile pricing has to be better than desktop,” Chief Business Officer Nikesh Arora told analysts on the post-earnings conference call.

CNNMoney attributed the stumble to mobile in a story by James O’Toole:

The challenge for Google is convincing marketers to pay as much for mobile ads as they do for desktop ads, a task that’s become increasingly pressing as Web usage shifts to smartphones.

Google Chief Business Officer Nikesh Arora said in a conference call Wednesday afternoon that the company’s mobile ad revenue is being held up in part because merchants haven’t spent enough time developing their mobile sites, assuming that customers will make more purchases via desktop.

“The journey is just beginning for advertisers on the mobile side,” he said. As advertisers begin to see the potential of mobile ads, including location targeting, Arora added that the gap between desktop and mobile ad rates would likely close.

“Right now we can lead the horse to water, but we can’t make it drink,” he said.

Part of the way Google is addressing this issue in the meantime is through the “enhanced campaign” strategy it introduced last year, which requires advertisers to buy across multiple platforms.

Taken all together this might indicate that Google will likely continue to see earnings growth slow in the near-term. What isn’t so clear is how they’re positioning themselves for the future. If you believe in the acquisitions and that cost cutting could come into play, then this might be a temporary setback. Otherwise, it could be the beginning of a long decline.