Alphabet shares fall despite forecast-beating earnings on rising Google traffic costs

Shares of Google's parent Alphabet slumped after the markets closed Monday. An EU fine took a big bite of the search engine company's profit.
A Google search page is seen through a magnifying glass in this photo illustration taken in Berlin on Aug 11, 2015.
A Google search page is seen through a magnifying glass in this photo illustration taken in Berlin on Aug 11, 2015. PHOTO: REUTERS

SAN FRANCISCO (REUTERS) - Alphabet reported a 21 per cent jump in quarterly revenue on Monday (July 25), maintaining a growth rate that is rarely seen among companies its size and suggesting the big sales gains enjoyed recently by the other Internet firms are not done yet.

Alphabet, the owner of Google and YouTube, said it made US$3.5 billion (S$4.8 billion) in net income on sales of US$26 billion. The profit would have been much larger but for a record US$2.7 billion European Union antitrust fine.

Still, the company noted that costs were rising faster than sales and warned that expenses would remain high as more searches shift to mobile devices.

The squeeze on expected future profit appeared to weigh on Alphabet's share price, which fell about 3 per cent to US$967 after the bell. Shares had closed up in regular trading and have gained 26 per cent for the year.

Alphabet's cost of revenue, a measure of how much money the company must spend to keep its platforms running before added costs such as research, rose 28 per cent, well above the growth in revenue itself.

The rising costs, including what Google pays to drive traffic to its search engine, hurt operating margins more than most people had expected, said Mr Doug Kass, president of Seabreeze Partners Management.

"This could be problematic going forward," he said.

Alphabet chief financial officer Ruth Porat, when asked about margins during a conference call with analysts, said the company was focused on getting bigger.

"As we've often said, we're focused on revenue and operating income dollar growth and not on operating margins," she said.

Increasing costs, Ms Porat added, are a result of more money going into high-growth products that she said would create value for shareholders.

With its latest profits, Alphabet reported US$15.7 billion in cash and cash equivalents, and another US$79 billion in marketable securities.

Alphabet and social media rival Facebook Inc, which together dominate the online advertising market, compete for advertising dollars.

This year, Google is expected to have US$73.75 billion in net digital ad revenue worldwide while Facebook is expected to take in US$36.29 billion, according to research firm eMarketer. Together, they will have about 49 per cent of the market, eMarketer said.

Facebook is due to report earnings on Wednesday.

The technology sector has led a big rally in US stocks. The S&P 500 information technology index is up 23.1 per cent this year, compared with a 10.4 per cent rise in the S&P 500.

Antitrust risk has shadowed Google for years, and antitrust enforcers in the European Union last month fined Google 2.42 billion euro (S$3.8 billion) for favouring its own shopping service.

The fine came in the first of three EU probes of Google's dominance in searches and smartphone operating systems, and analysts are going to monitor the downside closely, said Mr Josh Olson, an analyst with Edward Jones.

"It is not so much the money or the fine itself," he said, but "questions linger about what impact that could have on Google's Europe business and they did not really comment on that."

US antitrust enforcers thus far have chosen not to follow Europe's lead.

If not for the fine, Alphabet said that earnings per share would have been US$8.90 in the second quarter, compared with US$7 a year earlier. With the fine, Alphabet reported earnings per share of US$5.01, beating an average estimate of US$4.49.

Mr Sundar Pichai, chief executive officer of Google, said in response to an analyst question during Monday's call that Google would fight to continue bundling its Android operating system with popular smartphone apps such as Google Maps - a practice the EU antitrust officials are investigating.

"It's a very open market, open ecosystem, and it works well for everyone, and I expect that to continue," Mr Pichai said, adding that billions of people use Google products.

He was also appointed to the Alphabet board of directors on Monday.

Google's ad revenue rose 18.4 per cent to US$22.67 billion.

Revenue from other Google products, a category that includes the Pixel smartphone, the Play Store and Google's cloud business, rose 42.3 per cent to US$3.09 billion. Alphabet competes heavily in the fast-growing cloud business with tech companies Amazon.com Inc and Microsoft Corp.

Losses from other Alphabet units - an array of businesses known as "other bets" that includes the Waymo self-driving car company, thermostat-maker Nest and the life sciences firm Verily - narrowed to US$772 million from US$855 million a year earlier.