Alphabet profit margins slide due to rising Google costs

Irving Hamilton
February 5, 2019

Alphabet Inc's fourth-quarter revenue and profit beat Wall Street's expectations on Monday but sharply higher spending, as it added data centres, cloud engineers and marketed its services heavily during the holidays, anxious investors.

Alphabet's "other bets", the other companies owned by Google's parent, earned $6.49 billion.

Overall, Alphabet revenue was $136.8 billion for 2018, up 23% year-over-year, with $39.3 billion quarterly revenue, up 22%, the company said.

"Capex is growing at a sizable clip and the primary driver continues to be investing in technical infrastructure to support growth", Alphabet Chief Financial Officer Ruth Porat said in an interview with Bloomberg TV.

Operating margins, a measure of profitability, slipped to 21 percent from 24 percent due to higher fees to partner websites, as well as larger investments in self-driving subsidiary Waymo and research arm Verily.

The category Google calls "Other Revenues", which includes cloud, the Google Play store, and consumer hardware, saw $6.48 billion revenue in the fourth quarter, up from $4.96 billion year-over-year. It's likely that the majority of that money was in hardware sales, as Google doesn't break down how much it brings in through hardware versus through cloud services. Twelve analysts surveyed by Zacks expected $31.28 billion. The company also included a $1.3 billion securities gain in its net income, which means the company's actual business grew less that its net income numbers may suggest.

The company had $31.07-billion in total fourth-quarter costs and expenses, up 26 per cent from a year ago.

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Alphabet's earnings totaled $12.77 a share in the fourth quarter, about $2 a share above the consensus estimate.

Alphabet said its Q4 results slightly surpassed analyst expectations.

Concerns appear to be around how much Google is able to charge advertisers for ads. This year's earnings per share are expected to rise a modest 7% due in part to a comparison with 2018, which had almost $6 a share in equity gains.

The other segment of interest in Alphabet's ledger is "other bets", which is where the company lumps all non-Google business.

Another factor making the market wary was a 29 percent drop in "cost per click" or the average price of digital ads, the main source of revenue for the tech giant. Losses, however, doubled on the year-ago quarter, checking in at $1.32bn.

For starters, analysts believe Google will remain dominant in search.

"Acquisitions are an attractive complement to what we do to drive organic growth", Porat said on Monday. The three largest advertisers, according to Ad Exchanger, were Geico, Samsung and Disney, which together accounted for 15% of all advertising a year ago. It's also seeing an "uptick" in $100 million contracts, Porat said.

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