The Street got its first glimpse of CFO Ruth Porat, and she shined in her debut, revealing plans to cut costs and teasing investors with the prospect of a capital return program down the road. While there's plenty of optimism, the conference call left investors with a few questions -- namely should they expect a dividend? and what's going on with YouTube?
The Motley Fool's Dylan Lewis and Sean O'Reilly sift through the company's earnings and try to deliver some answers.
A full transcript follows the video.
Sean O'Reilly: Sergey Brin just made $3.5 billion, on this tech edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly, joined today by the devilishly handsome Dylan Lewis. How are you?
Dylan Lewis: Doing all right, Sean.
O'Reilly: I knew your mom was listening.
Lewis: Yeah. She tries to.
O'Reilly: For those of you who don't know, Google's broken its two yearlong flat streak and is up 14%.
Lewis: 13%, roughly. Depends on when you check.
O'Reilly: $80 a share, Sergey Brin owns two classes of stock; 43 million shares. Doing a little math, just short of $3.5 billion. The entire GDP of numerous African countries...
Lewis: Yes, just in one day.
O'Reilly: I came in today and one of our co-workers, Michael Douglass, emailed me and said "This is up. We should probably do 10%." I was like "This is awesome! We can do the tech show about this!" Then I emailed you, and here we are.
O'Reilly: They reported earnings. I'm surprised it's up this much. I'm interested to hear your thoughts. Run us through the release, first and foremost.
Lewis: Like you said, up 12% to 13%, net income looked good at $3.9 billion, roughly $6.43 per share, versus $3.4 billion a year earlier. Analysts had expected earnings of $6.70 per share, excluding certain costs and on that basis the company delivered $6.99 per share. That's a nice bump right there.
O'Reilly: They beat, but they beat by $0.12 per share. It wasn't outlandish or anything.
Lewis: It wasn't dramatic. Revenue looked good, too. It was up about 11% to $17.7 billion. Again, excluding certain costs they used traffic acquisition costs as something they're excluding. Revenue was $14.35 billion, analysts expectations were $14.27 billion.
O'Reilly: Was this the first quarter that they figured out mobile?
Lewis: I'm not sure if that's what it was. Like you said, it's a weird pop for what ultimately doesn't seem like a dramatic surprise on earnings.
O'Reilly: Right. If they doubled or something I would be on board with this. They're assigning an extra $100 billion...
Lewis: I think one of the things that people are most encouraged by are some of the statements that the company made about more conservative CAPEX and R&D spending and reigning in some of those costs a bit.
O'Reilly: I'm not going to get a driverless car, Dylan?
Lewis: I think they're still going to go after those moon shots, some of those programs they have with healthcare, some of those auxiliary businesses, but I think they might be a bit smarter about that.
O'Reilly: Got it. What else stuck out to you?
Lewis: I think one of the big things that we're always monitoring with Google is CPC. You look at revenue for them and with 90% of their revenue coming from ads you look at that equation and say "Are they increasing revenue based on volume, or are they doing it based on ad rates?"
O'Reilly: Correct me if I'm wrong, but last quarter it was on volume.
O'Reilly: We spent a good amount of time talking about that.
Lewis: Yeah, we've talked about it in the past and I think that trend it's just continuing. Aggregate paid clicks were up 18% year over year, 7% sequentially; whereas CPCs were down 11% year over year, and 4% sequentially. That trend continues.
O'Reilly: So, less per click in absolute pennies, but there's more of them so it's fine.
Lewis: Part of that is the transition to mobile and knowing that mobile CPCs are lower. Some of that is YouTube as well. It seems the company has made it clear that mobile CPCs are at the lower end of the spectrum, desktop is on the upper end, and YouTube is somewhere in between the two. As those become larger parts of the business we're going to continue to see CPCs meet somewhere in the middle there.
O'Reilly: Revenue growth looks good. They already have a 90% market share in the United States, they're killing it in Europe. In fact, so much so that they're trying to lob antitrust things at them. Where are they getting all this growth? Can they keep this up?
Lewis: I think so. It's really encouraging to see the TrueView YouTube growth. The way that works is, they're only billing clients based on ad impressions that are seen in their entirety.
O'Reilly: How nice of them.
Lewis: Yes. I know we're all used to skipping ads; those 15 second spots that wills show.
O'Reilly: "You can skip in 5 ... 4 ... 3 ..."
Lewis: They're building out that YouTube platform. That looks great. I do think the CPC dip is concerning. In the conference call they kept drilling home "Everything's OK with CPCs. Everything's OK with CPCs." I know the analyst narrative has been "This is something we're worried about" for a while. It's kind of like that guy that's trying to reassure you that things are great with his relationship. The more times he brings it up and says "Oh, everything's good, everything's fine; don't worry about it."
O'Reilly: "Things were never better."
Lewis: Yeah. The more you're like "I don't know."
O'Reilly: Have you caught wind of any talk about the competitive landscape in online ads? 10 years ago, if you said "There's this company making gobs of money off online ads and clicks" I would have though "Google." There's literally no one else. Now you've got Facebook; there's more competitors. If I'm going to spend $5 million on a crazy, big, online ad I have some choices now.
Lewis: Yeah. I think the targeting is unparalleled with Google. Facebook is obviously great, it's super granular, but I think Google's targeting is still going to be better just because it's knowing exactly what you're searching for when you're searching for it, and they can serve up ads based on that. I don't know that anyone will beat them there, but it's definitely becoming a slightly more competitive landscape and there's more suitors for those ad dollars.
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For part two we're going to talk about their giant bank account, which isn't quite Apple par.
Lewis: Yeah, but it's sizable. Right now Google sits at about $70 billion in cash on the balance sheets, which is insane. That is a lot of money. That's about 1/3 of what Apple has on the books.
O'Reilly: Google will get there someday, I'm sure.
Lewis: Still, a lot. Obviously, this is something that people start to think about with earnings. "What does the capital return policy look like?" You see some of these really big tech companies -- Microsoft, Apple...
O'Reilly: Cisco, even.
Lewis: Cisco. Once you become monolith you have to get into the capital return policy. You need to reward your shareholders with some dividends, or some share repurchases. I think a lot of the coverage I've been reading about their earnings has really fixated on this one quote from their CFO, Ruth Porat, which think was taken out of context.
O'Reilly: When was this?
Lewis: This was Thursday. It was "What do we potentially need for capital return?" This was in the context of talking about potentially loading up on some debt. Their debt load is pretty low right now. I think any near term expectations of a dividend or share repurchase are overblown.
O'Reilly: What did he say?
Lewis: The full quote was "But if you step back as I've looked at it, the key issue is: what do we do for working capital? What do we need for CAPEX? What do we need for M&A? What do we potentially have for capital return? How'd this one thing about financing the various opportunities that we have." That list is something she reiterates later on in the same order. When asked to specify, she talks about what she meant. She hits CAPEX, M&A, and then capital return again. I think it's clear that's where their priorities are. She's made it clear that it's speculative at this point. I don't know. I'm not sold on any dividend coming up anytime soon.
O'Reilly: Right. On the flip side, can you imagine going back in time to a long time Apple share holder in the earlier 2000s and saying "Someday your company is going to pay this giant dividend. It's going to have a $170 billion bank account." They'd be like "No way." Someday Google might get there. You think the street's looking a little too much into this?
Lewis: Yeah. I think they're getting a little over-eager. One of the things they talk about in the conference call is, one of their biggest ROIs has been their investment in the search platform. They've been extremely smart with their M&A; YouTube was an acquisitions. They've spent that money very wisely, and it's allowed them to absolutely explode in growth. While it might be compelling to reward shareholders and build some stability there, if they're allocating capital that well, why get in the way of that?
O'Reilly: It's always tricky, but management does have three choices. They can keep the money and do what Google's doing -- pay dividends or buy back stock; and if you're going to do the latter two you need to ask yourself what the shareholders are going to do with that. If it doesn't meet the threshold of what you think a fair return for an investor is -- 8% to 10% per year -- Google's return on equity is very high, and they're very good at what they do. Letting them keep it, even with their huge size, isn't that crazy at this point.
Lewis: We talk about the moon shots and how they have all these side project they're working on. If one of them turns into something big; that's huge.
O'Reilly: Game over.
Lewis: I think you're right. That possibility is a lot more potent in their bank account than it is in their shareholders.
O'Reilly: Sergey deserves that $3.5 billion that our society gave him today. This is what I really want to talk about because it's kind of a continuation on what we did a week or two ago. What's up with YouTube? It's break even. Do they acknowledge "Yeah, we have it, and it's kind of fun to have. Sergey loves watching cat videos on YouTube and we just kind of have it"?
Lewis: Everything I've read on YouTube has said it's break even, so far. That's maddening. How is this not a profitable platform?
O'Reilly: How?! Everybody uses it.
Lewis: Unfortunately, everything Google's released to the public so far via financial statements and quarterly calls hasn't broken it out. It's something we've referenced before, but it's a lot like Amazon Web Services, where we weren't really sure what it was for a while and what kind of revenue contribution it was. We had some ideas from analysts, we had some insiders leak some information here and there with YouTube's contribution; but for the most part, we don't have an official statement that says "This is what it is." We're stuck with these user metrics that the company is releasing and right now they're at over 1 billion users. Watching Time Growth is up 60% year over year.
O'Reilly: I'm trying to think if I watch things longer on YouTube now.
Lewis: I think more people are listening to music on there.
O'Reilly: Yeah. For sure. The Vevo and -- yeah. For sure.
Lewis: Like I said before, YouTube -- CPC-wise -- is between desktop and mobile. Something they've talked about in their conference calls is the gap between mobile and desktop is narrowing. I think companywide the CPC is probably going to be somewhere along where YouTube is. Theoretically it becomes something that's profitable at some point.
O'Reilly: Wow. Awesome. Very good. Thanks for your thoughts.
Lewis: Always a pleasure, Sean.
As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening, and Fool on!