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Alphabet, Inc. Is Doing Just "Fine"

By Steve Symington - Jul 25, 2017 at 8:00AM

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The internet search juggernaut took a record EC fine in stride with its strong second-quarter results.

Alphabet Inc. (GOOGL -0.21%) (GOOG -0.27%) announced exceptional second-quarter 2017 results on Monday after the market closed, demonstrating solid profitability even after accounting for a staggering $2.7 billion European Commission fine. Nonetheless, shares are down modestly in after-hours trading as of this writing.

Let's refine our earnings query, then, to see how the parent company of Google fared as it capped the first half of the year, as well as what investors should expect going forward.

Googleplex campus

Image source:: Alphabet/Google.

On that massive fine

For perspective, Alphabet told investors weeks ago that this report would account for the staggering fine, which was imposed after the EC ruled that Google has unfairly favored its own comparison-shopping service over those of competitors in Google Search results. At the time, Alphabet also promised it would review the decision as it considers an appeal. 

During the subsequent conference call on Monday, Google CFO Ruth Porat noted that there's not much to update in that regard.

"We are still early in our analysis of the decision in the right next steps, and we do have time to notify the commission of proposed remedies as well as implement changes," Porat stated. "The main thing is, we are very focused on helping users and advertisers, and [...] reviewing our options is an ongoing matter."

Alphabet's headline numbers

In the meantime, Alphabet's quarterly revenue increased 21% year over year (23% at constant currency) to $26.01 billion. Including the fine, that translated to a 30.8% decline in operating income to $4.132 billion, a 27.7% decline in net income to $3.524 billion, and a 28.4% decline in net income per diluted share to $5.01.

Alphabet doesn't provide specific quarterly financial guidance. So while we don't usually pay close attention to Wall Street's expectations, consensus estimates predicted lower earnings of $4.83 per share on revenue of just $25.6 billion.

For further perspective, Alphabet also breaks its results down between two primary segments: Google and "Other Bets." Here's how both segments performed excluding the fine on a year-over-year basis:

Metric 3 Months Ended June 30, 2016 3 Months Ended June, 2017 Year-Over-Year Growth
Google segment revenues $21.315 billion $25.762 billion 20.9%
Google adjusted operating income* $6.990 billion $7.803 billion 11.6%
Other bets revenues $185 million $248 million 34.1%
Other bets operating income (loss) ($855 million) ($772 million) N/A

*Excluding the EC fine. Data source: Alphabet Inc.

From Google

Google once again drove the majority of Alphabet's overall revenue, as well as all of its operating income for the quarter. For that, investors can thank Google's enviable stable of popular products from Search to Chrome, Android, Google Play, Maps, Gmail, YouTube, as well as Commerce, Apps, Cloud, and hardware.

Next, Google's advertising business remains crucial and strong. Ad revenue rose 18.4% year over year to $22.672 billion. That included 19.6% growth in Google properties ad revenue to $18.425 billion, driven primarily by strong performance insights from both mobile search and YouTube. Network members' properties also delivered 13.5% growth in revenue, to $4.247 billion.

Drilling deeper into advertising performance, aggregate paid clicks skyrocketed 52%, including 61% growth in paid clicks on Google's properties and a 9% increase in clicks on network members' sites. This also marked strong acceleration from last quarter's respectable 44% growth.

By contrast, aggregate cost per click (a measure for how much Google makes per ad) fell 23%, including a 26% decline in cost per click on Google properties and an 11% drop from network members' sites. But this also extends a recent streak for the somewhat misleading metric, which owes its persistent drops largely to the outperformace of YouTube's TrueView ads. Recall the TrueView system, for its part, usually reaches consumers earlier in the purchase funnel, so its ads typically monetize at lower rates. But with more than 1.5 billion monthly viewers who watch an average of 60 minutes of YouTube content per day on their phones and tablets, you won't find Google complaining as it steadily improves monetization at one of its most promising platforms.

Finally, we can't forget Google's non-advertising revenue sources -- primarily including Play, hardware and cloud products -- which drove a solid 42% increase in revenue to $3.1 billion

From other bets

Then, of course, there's Alphabet's "Other Bets," comprised of high-potential, early stage businesses operating in a variety of industries, with many still in their pre-revenue stages. These businesses unsurprisingly remained unprofitable, albeit generating a narrowed operating loss of $772 million for the quarter. Other Bets revenue simultaneously climbed more than 34% year over year to $248 million, driven mostly by sales of Nest connected home products, Verily life sciences solutions, and Fiber high-speed internet.

That said, Porat also pointed out during the call that Calico (which focuses on extending human longevity) has now formed more than 20 active collaborations with other life sciences companies and academic institutions. Project Loon also had the chance to do good by delivering its balloon-internet technology to tens of thousands of people affected by floods in Peru. And Alphabet's self-driving car unit, Waymo, recently formed its own partnerships with both Lyft and Avis.

"Almost two years after the creation of Alphabet," added Porat, "we see the benefits of our focus within Google and Other Bets, and are pleased with the opportunities we have for sustained revenue and earnings growth."

Looking forward

Porat summed up the call by appropriately elaborating on Alphabet's long-term mentality: 

Our revenue growth and Alphabet structure give us both the opportunity and confidence to invest in our businesses for the long-term. We are doing that, while being very deliberate about the focus, scale and pace of investment and remain committed to being conscious in our use of all resources. We're increasing investment in areas where we see the most potential, scaling back in others, and sharpening our organizational effectiveness to make the most of the resources available.

In the end, while it's unclear how Alphabet will proceed regarding its big EC fine at this stage, it's also encouraging that the company remains so solidly profitable that the charge can be easily absorbed in its entirety over a single quarter. Given the continued strong financial performance of Google, Alphabet's exciting irons in the fire with "Other Bets, and its encouraging long-term view, I think investors should be more than happy with where it stands today.

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