Alphabet Falls on Concern About Rising Google Traffic Costs

By Bloomberg

(Bloomberg) — Alphabet Inc. shares fell after second-quarter results resurfaced a worrying trend: The company’s costs are rising as it spends more to expand Google’s newer, fastest-growing advertising businesses.

The company reported sales, minus partner payouts, were $20.92 billion, in line with analysts’ consensus forecasts, but below some more bullish expectations. Estimates ranged from $20.55 billion to $21.61 billion, according to data compiled by Bloomberg. Profit was also hammered by a record antitrust fine from the European Union.

The main Google division generated revenue of $22.67 billion in the latest period, but 22 percent of that was paid out to partners as traffic acquisition costs, also known as TAC. A year earlier, TAC was 21 percent of Google revenue.

Most of Google’s growth comes from mobile search ads, YouTube marketing spots and automated marketing called programmatic campaigns. The company has to share more of the money from those ads than it does with its original web search marketing slots.

“Growth in TAC accelerated for the third straight quarter, suggesting rising costs of future ad dollars,” said James Cakmak, an analyst at Monness Crespi Hardt & Co.

Alphabet shares fell as much as 3.5 percent after closing at $998.31 in New York.

Chief Financial Officer Ruth Porat said the company expects TAC for Google properties such as Search and YouTube to continue to increase, suggesting margins may shrink. She said the company is focusing on increasing total profits, rather than growing profit margins.

TAC payouts primarily go to network websites and mobile partners, which took the largest chunks from Google sales since 2009, according to Pivotal Research Group analyst Brian Wieser. Distribution partners, such as mobile carriers and handset-makers like Apple Inc., brought in more than 10 percent of Google’s revenue on its own properties. Other companies that use Google’s expansive ad tech systems took higher partnership payments. Wieser attributed the rising costs to demands from marketers for better quality video ads that are “brand safe.”

Cakmak and other analysts also noted that a 26 percent jump in Alphabet stock so far this year left a high bar for the company’s results this quarter. 

Google’s primary advertising business posted growth of around 18 percent. "People were looking at 20 percent growth here and they came in a little bit below that," said Ron Josey, an analyst at JMP Securities.

Alphabet shares fell as much as 3.5 percent after closing at $998.31 in New York.

Regulators in Europe levied a $2.7 billion penalty in June, saying Google skewed its general search results to thwart smaller shopping search services. The Mountain View, California-based company disagreed and is considering an appeal. Two more antitrust probes against Google sit on the EU docket, a concern for some analysts worried about the impact of any forced changes to Google’s business.

The company accounted for the fine as a one-time dent on profit during the quarter, bringing net income to $5.01 per share. Analysts were expecting $4.45 per share, including the EU fine, according to figures compiled by Bloomberg.

Spending on Alphabet’s “Other Bets” fell sharply during the quarter. Porat attributed this to an ongoing retreat in the expansion of its Google Fiber fast internet service. 

Still, spending on Google’s businesses increased. In particular, the company has plowed money into its cloud-computing business, which Porat said was one of the fastest-growing divisions. Google said it won three times as many cloud deals exceeding $500,000 as it did last year. That was the most the company has disclosed about its cloud sales to date.