A logo stands above the entrance to Google Inc.’s Kings Cross office in London, U.K. (Photographer: Simon Dawson/Bloomberg)

Google Ad Surge, YouTube Optimism Send Alphabet Shares Up

(Bloomberg) -- Alphabet Inc. beat projections for third-quarter sales and earnings after a surge in Google ad volume helped the web-search giant shrug off concerns about regulatory scrutiny and an expensive foray into hardware.

Sales for the quarter rose to $22.27 billion and profit was $9.57 a share, the company said. Analysts on average estimated sales of $22 billion on earnings of $8.34 a share. Executives lauded "tremendous results" in mobile search ads. Yet the company cautioned investors the biggest costs that come with those ads -- fees paid to distribution partners -- will continue to rise, along with expenses from Google’s foray into devices and holiday-season marketing.

"We had a terrific quarter, with revenues up 24% year on year, reflecting strength across Google and Other Bets," Chief Financial Officer Ruth Porat said in the statement. It’s the first time in an earnings release that the CFO praised Alphabet’s non-Google units, in self-driving cars and other experimental fields, which sharply curbed their costs during the quarter.

Alphabet shares rose 3 percent in after-hours trading. That put the stock on course for a record in Thursday trading. It’s up 25 percent so far this year.

Porat and Google Chief Executive Officer Sundar Pichai highlighted strong performance from Google’s YouTube video service and cloud business. YouTube has racked up more than 100 million viewing hours per day in the living room, a 70 percent increase in the past year, Pichai said. He also touted YouTube’s new subscription service, but did not share any figures.

Despite the robust results, the primary focus for investors was Google’s Traffic Acquisitions Costs, payments to phone-makers and web browser makers that run Google search and ads. TAC to these distribution partners, such as Apple Inc., jumped 54 percent to $2.4 billion in the third quarter.

Porat attributed the TAC acceleration to wider adoption of mobile devices, where Google has to pay more for search access, and "changes in partner agreements." She did not specify the partners. "We do expect it to increase some from here," the CFO said on the earnings call. "You’ve got a couple of factors going on."

During the quarter, two other events raised questions about how long Google could keep up robust revenue and profit growth: another turn in the ongoing European regulation drama, and a deeper investment in devices.

In September, the deadline arrived for Google to meet demands for the European Union antitrust case on shopping ads. Google agreed to tweak its paid search results for products in the continent, although it’s still appealing the charges. These product ads have helped drive sales and profit growth, but Google investors are more concerned about a probe into Google’s Android software on mobile device.

Also in September, Google agreed to pay $1.1 billion for about 2,000 engineers from HTC Corp., in effect an acquisition of skilled hands to expand Google’s line of Pixel smartphones. The new hardware business is a key weapon in Google’s fight against Apple Inc. and Amazon.com Inc. in the next wave of computing devices. Yet building and selling hardware tends to depress margins, and it’s a market Google has struggled with historically.

On the earnings call, Pichai said the HTC deal was a "win-win" for both companies. The incoming hardware engineers, he said, were "best-in-class," who would help Google design its phones, speakers and virtual-reality gadgets.

Google doesn’t break out device sales. However, the company’s Other Revenue category includes the hardware business. Revenue there was up 40 percent to $3.41 billion. Google said the largest contributor to that line item during the quarter was its cloud unit. Pichai named two new cloud customers: Kohl’s Corp. and PayPal Holdings Inc. 

The CEO also touted the division when discussing some of Google’s fledgling online retail partnerships, alliances formed to combat Amazon’s dominance. "Almost all of our e-commerce providers are very interested in cloud, for obvious reasons," Pichai said. Amazon’s cloud unit posted $4.6 billion in third-quarter sales on Thursday, up 42 percent.

Alphabet’s more ambitious business units generated the most sales ever in a quarter. Other Bets, subsidiaries like its self-driving car program, Waymo, and home-device maker Nest, continued to pare expenses as well. The group lost $812 million in the quarter, down from $861 million in the same period in 2016. Overall, the units reported sales of $302 million, primarily from Nest and the Google Fiber broadband service.

Costs were mainly reduced by pulling back on an expansion of the Fiber business. "We paused the rollout to improve the technology," Porat told Bloomberg Television.

©2017 Bloomberg L.P.