This week was an important one for technology investors, as Facebook (META 4.29%) Amazon.com (AMZN 2.43%), and Alphabet (GOOGL 1.97%) (GOOG 2.05%) were all scheduled to report earnings. The three companies are the three largest digital ad platforms in the U.S. and together account for nearly 70% of all digital advertising dollars. Facebook and Alphabet have already reported, with Amazon waiting in the wings (as of this writing).
U.S. gross domestic product (GDP) shrunk in the first quarter, and many experts agree we are almost certainly in a recession. Many companies have been shifting to emergency mode, preparing to slash expenses and batten down the hatches to ride out the economic storm. When looking at corporate budgets, one of the first areas that is inevitably hit is marketing spend, which doesn't bode well for the digital advertising space.
Yet comments made by execs from both Facebook and Google seemed to turn that notion on its head.
A surprise from Google
Considering that investors were considering apocalyptic results from Alphabet, the results were surprisingly robust.
For the first quarter, Alphabet reported revenue of $41.16 billion, up 13% year-over-year but down from the 17% pace of growth in the prior-year quarter. Excluding the fine levied by the European Union last year, operating margins dipped to 19%, down from 23%. This resulted in adjusted earnings per share of $9.87, a decline of 17%.
But it was comments by Alphabet CFO Ruth Porat during the earnings conference call that seemed to suggest that things in the digital advertising space weren't nearly as bad as many feared. She acknowledged that results took a hit as the result of the COVID-19 pandemic, saying, "Performance was strong during the first two months of the quarter, but then in March we experienced a significant slowdown in ad revenues."
That wasn't a shock to anyone following the economic downturn, but the surprise came when Porat said (emphasis mine), "We have seen some very early signs of recovery in commercial search behavior by users," while acknowledging it still wasn't clear if the trend was sustainable.
A similar revelation from Facebook
Given the severity of the situation, Facebook's results were also stronger than expected.
For the first quarter, Facebook generated revenue of $17.7 billion, up 18% year-over-year, but down from the 26% growth it registered in Q1 2019. Excluding a settlement in the prior-year quarter, net income of $4.9 billion fell by 9.7%.
Equally as important for Facebook, daily active users grew to 1.73 billion, up 11% year-over-year, while those who use the platform monthly climbed to 2.6 billion, up 10%. It's important to note that this ticked up from the consistent pace of 8% to 9% growth the company has reported in each of the past four quarters, showing that the worldwide lockdowns are driving users to Facebook.
Evidence suggests that the worst-case scenario that many expected hasn't materialized. On the conference call, chief financial officer Dave Wehner revealed that the turnaround in ad spending was already happening:
After [an] initial steep decrease in ad revenue in March, we have seen signs of stability reflected in the first three weeks of April. Ad revenue has been approximately flat compared to the same period a year ago.
Wehner went on to say the company was "understandably cautious," given the potential for additional contraction in Q2.
More challenges to come
Investors were clearly pleased by the results. Google rallied 8% in the wake of its earnings report, while Facebook jumped about 5%.
However, this situation is still evolving and in the coming weeks and months, investors could still view the glass as half full or half empty. On the one hand, the impact on digital advertising from the pandemic wasn't nearly as severe in the first quarter as many (myself included) believed, but this isn't over yet. The stay-at-home orders are only now beginning to be lifted, and it will be some time before the world economy is fully recovered. There's little doubt that the second quarter will be even more challenging.
Facebook and Alphabet are among the technology leaders and strong investments for the long term, but there's still likely more pain yet to come.