Alphabet Touts Cloud, YouTube to Ease Pain of Google Costs

(Bloomberg) -- After sinking billions into driverless cars, internet balloons and life-extension research, Alphabet Inc. is being weighed down by more mundane expenses -- the cost of running its behemoth online search business.

Google’s parent company reported fourth-quarter profit that missed analysts’ estimates, hobbled by rising payments for search and advertising distribution to companies like Apple Inc., as well as higher marketing spending on its line of consumer devices during the holiday quarter. Alphabet also absorbed a $9.9 billion hit from tax owed on overseas cash following recent changes to U.S. law. The shares fell as much as 6 percent, the most since April 2016, to $1,111.17 in New York.

Though the numbers heightened concern about the profitability of the company’s main business, executives sought to reassure investors that Google would quickly tame its distribution bills. And Google emphasized the promise of businesses outside of search: YouTube viewership and video advertising are booming; the nascent device business doubled shipments last year; and its cloud-computing arm, where it’s plowing in money and personnel, is finally ready to challenge market leaders Amazon.com Inc. and Microsoft Corp.

Analysts had mixed opinions of Alphabet’s results. Some trimmed their estimates and Stifel cut its rating to hold. "Google posted very strong revenues yet again (up a remarkably stable 24% year-over-year); however, margins fell significantly more than expected," Ben Schachter, an analyst at Macquarie, wrote in a Friday note to investors.

For the first time, Google disclosed sales figures for its corporate technology division, which offers cloud-computing services and workplace apps. Chief Executive Officer Sundar Pichai told investors that the business now brings in $4 billion in revenue on an annualized basis.

While that pales next to market leader Amazon, which posted $5.1 billion in cloud sales for the fourth quarter alone, Pichai said Google signed three times more deals of over $1 million during 2017 compared with the prior year. More critically, the cloud arm completed all the compliance and technical requirements to service major companies across wide industries, where it’s leaning on its machine-learning and data prowess to win customers.

"We’re in deals now -- we can support being in those deals," Diane Greene, CEO of Google Cloud, said in an interview. "So now we can double down on the innovation again."

Alphabet’s total fourth-quarter sales, minus payments to partners, rose to $25.9 billion, in line with the average analyst projection of $25.6 billion, according to data gathered by Bloomberg. The tax expense resulted in a net loss of $3.02 billion, or $4.35 a share, the company said Thursday in a statement. Before that cost, profit was $9.70 a share, falling short of the average analysts’ projection of $10.04.

An ongoing concern for investors is those payments Google makes to phone makers and web browsers, known as traffic acquisition costs, or TAC. That number rose to $6.45 billion, or 24 percent of Google’s overall ad revenue. Google again attributed the surge to the rising number of ads it runs on YouTube, mobile devices and automated systems, which require sharing more money with partners. Yet Chief Financial Officer Ruth Porat said that Google expects TAC costs stabilize in the coming quarters.

Investors have also been watching for answers about the impact of turbulence at YouTube on Google’s growth. Advertiser outcry over offensive content on the massive video site started in early 2017 and then resurfaced in the fall, after grotesque videos were spotted on YouTube’s channels for children. Several marketers paused spending to avoid having their spots run alongside the content in question. Google doesn’t break out YouTube sales.

YouTube introduced a series of policies to ease these concerns in January, including the manual vetting of videos in the premium package for advertisers. "Overall on YouTube, we are doing a lot to protect the ecosystem," Porat said in an interview following the report.

Despite the steady growth in Google’s ad sales, it continued to struggle with lower ad rates, primarily from the rise in mobile ads. In the fourth quarter, cost-per-click fell 14 percent. In recent months Amazon has expanded its ad engine aggressively, aiming for many of the same digital budgets that Google gets.

"You still have a fairly substantial competitive threat from a new entrant," Norm Johnston, head of WPP’s Mindshare, said after Google’s report. "It’s a bit disconcerting that they can’t stabilize mobile search."

Another weight on margins comes from the amount Google has poured into hawking its Pixel phones, smart speakers and other devices. Sales and marketing expenses rose to $4.3 billion, or 13 percent of overall sales, in the recent quarter. Porat said the bump in costs came from the "seasonality" of its hardware division and would taper off.

Amazon, in particular, has invested heavily in its smart-speaker lineup, which some analysts see as a long-term threat to Google’s core ad business -- because more people may go straight to Amazon via voice command when searching for something to buy. Pichai said he was "excited" about sales of Google’s own Home speakers, but declined to give specifics on sales for the device or on Google’s broader e-commerce strategy. "We invest a lot there," he said on the earnings call. "Consumer behavior is changing. But we’re comfortable given the breadth of things we’re doing."

Despite YouTube’s content issues, the company has been less vulnerable than its primary ad rival, wrote Brian Wieser, an analyst at Pivotal Research Group. "Google appears to be better positioned than Facebook," he wrote on Thursday.

Porat was enthusiastic about Alphabet’s driverless-car unit, Waymo, noting that the company will begin its ride-hailing service later this year. The remainder of Alphabet’s Other Bets category, which includes its Fiber internet and Nest home devices, got little mention. Other Bets posted $409 million in revenue, with an operating loss of $916 million. Porat told investors the company will continue to "calibrate" investments in those units.

The company also named director John Hennessy as chairman, replacing Eric Schmidt, who said in December he would step down from the role. Schmidt remains on the board. Alphabet also said it authorized a share buyback of $8.6 billion of its stock. That buyback included a math joke, a quirky Google tradition: The full amount authorized -- $8,589,869,056 -- is a "perfect number," or a number that is equal to the sum of all its divisors.

--With assistance from Emily Chang

To contact the reporter on this story: Mark Bergen in San Francisco at mbergen10@bloomberg.net.

To contact the editors responsible for this story: Jillian Ward at jward56@bloomberg.net, Mark Milian

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