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Alphabet Inc. Earnings Shine on Mobile Search, YouTube Strength

By Steve Symington - Oct 23, 2015 at 7:27AM

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Approving its first significant capital returns program in style didn't hurt, either.

As the newly formed holding company of Google and its various operating subsidiaries, Alphabet ( GOOG 0.90% )( GOOGL 0.81% ) isn't a household name just yet. But you'll be hard-pressed to find an investor willing to complain about Alphabet's first earnings report since formally implementing its reorganization earlier this month.

After climbing 1.4% in Thursday's regular session, Alphabet stock skyrocketed another 11% in after-hours trading after it revealed third-quarter revenue jumped an impressive 13% year over year to $18.68 billion. That translated to a 26.4% growth in operating income to $4.7 billion and a 45.3% increase in GAAP net income to $3.98 billion, or $5.73 per diluted share. On an adjusted basis -- which primarily means excluding stock-based compensation -- Alphabet increased earnings 18.7% to $5.1 billion and 17.6% on a per-share basis to $7.35.

Analysts, on average, were much less optimistic on both fronts, with consensus estimates calling for third-quarter earnings of $7.21 per share on revenue of $18.53 billion.

"Our Q3 results show the strength of Google's business, particularly in mobile search," stated Google CFO Ruth Porat. "With six products now having more than one billion users globally, we're excited about the opportunities ahead of Google, and across Alphabet."

For reference, those six 1-billion-plus user products are Search, Android, Maps, Chrome, YouTube, and Google Play, the last of which Google CEO Sundar Pichai noted just crossed the 10-figure milestone during the third quarter.

A Google kind of joke
Google's board also approved its first ever significant capital returns program, specifically in the form of a massive authorization to repurchase up to $5,099,019,513.59 of Class C capital stock beginning in the fourth quarter.

And, yes, that is a strange number. But while it might be tempting to round it to an even $5.1 billion, a passing familiarity with Google's math-induced quirkiness should be enough to immediately arouse suspicion that there's more to it than meets the eye. Sure enough, a little math sleuthing reveals the figure was intentionally approved to the penny: 5.09901951359 happens to be the approximate square root of -- wait for it -- 26, the number of letters in the alphabet.

All kidding aside, these are very real, very large numbers with which Google plans to increase shareholders' slice of the pie. And with nearly $72.8 billion in cash on its balance sheet at the end of the quarter (of which around $42 billion, or 58%, is held overseas), Google can certainly afford to do so.

Nonetheless, Porat insisted during the subsequent conference call, "Our primary uses of capital will, of course, remain CapEx and M&A across the breadth of our businesses."

Digging deeper
Google also generated $6 billion in cash from operations during the quarter and, after capital expenditures of $2.37 billion related to production equipment, data centers, and facilities, achieved free cash flow of $3.63 billion.

Keeping in mind Alphabet generated more than 53% of total revenue outside the U.S. during the quarter, its double-digit growth is also made all the more impressive considering it was achieved in the face of continued foreign exchange headwinds. On a constant-currency basis, Alphabet's revenue would have jumped a staggering 21% year over year to $19.97 billion. To its credit, however, Alphabet's foreign exchange risk management program was able to partially negate that impact with hedging gains of $286 million.

Revenue from Google's core advertising business rose 13% to $16.8 billion, representing 89.9% of total sales, down from 90.4% last quarter and 91.1% in the same year-ago period.

Within that, revenue from Google websites rose 16% year over year to $13.1 billion. According to Porat, this reflects "substantial strength in mobile search due to ongoing improvement in ad formats and delivery to better address how consumers use their mobile devices." Porat went on to note YouTube served as a solid complementary growth driver, as it continued to enjoy considerable strength driven by growth in video advertisements across both TrueView and Google Preferred.

Meanwhile, revenue from Network Members' sites rose 4% year over year to $3.7 billion, driven by significant growth of programmatic ads, and offset by declines from traditional businesses.

Aggregate paid clicks rose 23% year over year, helped by 35% growth in paid clicks on Google websites, and held back by a 5% decline in paid clicks on Google Network Members' sites. Aggregate cost-per-click fell 11%, including a 16% decline on Google sites, and a 4% decrease from Google Network Members' sites. 

Finally, "other" revenue rose 11% year over year to $1.9 billion, driven by a combination of strong growth in Play and Google for Work (including Cloud), and offset by both the absence of revenue recognized under a licensing agreement during last year's third quarter, as well as lower hardware sales as Google reached the end-of-life cycles for certain Chromecast and Nexus devices.

Looking forward
Porat also offered the following color on what to expect when Alphabet begins reporting on a segment basis next quarter:

We intend to provide additional details for Google on the one hand, and all the other Alphabet businesses on the other hand. We refer to those other Alphabet businesses as "Other Bets." We expect Other Bets to include among others, Access and Energy, Nest, Life Sciences, our Investment Arms, and X, which is where driverless cars and certain other incubation efforts reside. Specifically, we intend to disclose for both Google and Other Bets revenues, profitability, and CapEx. By doing this, we expect that you will be able to better understand how we manage the businesses, including the pace and allocation of our investments.

Personally, I can't wait until Alphabet pulls back the curtain on next quarter's report to garner that better understanding. But at least Google investors can revel in this truly impressive third-quarter report as they wait for that to happen. Because when it does, I'll be thoroughly unsurprised if Google stock doesn't trade significantly higher than it sits today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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