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Should Alphabet Inc. Investors Be Concerned About Ad Growth In 2016?

By Tim Brugger - May 2, 2016 at 12:34PM

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The search king’s had a rough go of it since announcing earnings, and according to one estimate, the rest of 2016 may not be any better.

If investors want an example of a fast-growing company and industry leader that's become a victim of its own success, it's Alphabet (GOOG 5.20%) (GOOGL 5.11%).

By virtually every important metric, Alphabet began 2016 with a bang. Outstanding top-line results of $20.26 billion were 17% higher than the year-ago Q1; earnings-per-share (EPS) climbed 16% to $7.50 on a non-GAAP basis, excluding one-time items; and Alphabet's other revenue line item -- consisting of Google Play, Fiber, and the like -- climbed 24% to $2.1 billion.

The result of Alphabet's stellar kick-off to 2016? Alphabet's stock price is down a whopping 9% to $691.02 as of April 28, a week after earnings were announced. Missing analyst expectations and ongoing losses from its other bets unit -- home of Alphabet's "moonshots" -- were the culprits.

Despite its spiraling stock price, Alphabet fans shouldn't be overly concerned. After all, its results were sound, regardless of analysts' expectations, right? Well, maybe -- unless a new report from eMarketer that suggests ad revenues in Alphabet's Google are going to take a beating in 2016 prove correct. On top of the current unease, declining ad sales this year would add insult to Alphabet's injury.

Chart source: eMarketer.

First, the bad news
Worldwide net ad revenues have been slowly declining the past few years, according to eMarketer. In 2014, Google enjoyed a 19.1% jump in global advertising revenue. That figure declined to 15% last year, and, according to eMarketer estimates, net ad sales growth will drop to just 9% in 2016. And the downward trend won't stop there.

By 2018, eMarketer predicts Google will grow ad sales just 7.3%. It should be noted that even at a meager 7%-plus improvement, Google is still estimated to rake in $66.71 billion in net ad revenue in 2018, easily outdistancing its primary competitor, Facebook (META 7.19%), along with every other digital advertiser on the planet. Single-digit ad growth still leaves Alphabet with 30.9% of the world's digital net ad revenue this year, followed by Facebook in a distant second with 12%, according to eMarketer.

Following a blowout quarter that sent Facebook stock to new all-time highs, thanks in part to its 57% jump in ad revenue to $5.2 billion, the "distant second" position it now occupies may not be "distant" for as long as some may have thought.

A more pressing concern for shareholders than Facebook's closing the digital ad leadership gap is the response from investors following Alphabet's "disappointing" earnings. When a 17% revenue increase and 16% year-over-year non-GAAP EPS improvement spark a nearly double-digit share price decline, how will investors and pundits react should Alphabet end 2016 as eMarketer predicts? Time will tell, but the odds that single-digit ad growth passes without notice or concern are pretty slim.

What it means
Alphabet's sheer size ensured that the pace of growth from its core business would slow eventually, even as the digital advertising market continues to skyrocket. And Alphabet, with its nearly 31% of the world's digital ad market, is still getting more than its fair share. According to eMarketer, digital advertising spend will surpass TV as the No. 1 choice of the world's marketers in 2017. The global ad market is expected to reel in $579 billion this year.

An arrow in Alphabet's quiver that suggests eMarketer's estimates could be overly pessimistic is the ongoing monetization of YouTube. The video service is estimated to add a net $5.18 billion to Alphabet's revenue coffers this year, up from an estimated $4.28 billion in 2015. Alphabet doesn't share YouTube revenue specifics, so investors are left with estimates and eMarketer shows increasing numbers.

Chart source: eMarketer.

The year-over-year 21% forecast revenue growth of YouTube to over $5 billion is nothing to sneeze at, and it may prove too conservative. Alphabet said its YouTube "partner revenue" is up 50% year over year for the third straight year. Alphabet's TrueView ads -- which make it easier for consumers to purchase advertised products -- are also a YouTube hit with marketers.

No, long-term Alphabet investors, the sky isn't falling. But be prepared: In the near term at least, should declining ad growth projections come to pass, there will be more hiccups in Alphabet's future.

 

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