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Google parent Alphabet hit by rising costs

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Via Financial Times

Alphabet on Monday dealt Wall Street the latest unpleasant surprise over its spiralling expenses, as it revealed that a renewed hiring binge and the heavy costs of competing in the video streaming wars had weighed on its third-quarter earnings.

The news wiped 2 per cent from the tech holding company’s shares in after-market trading, overshadowing what was otherwise a very strong performance from its Google advertising business in the quarter.

The setback highlighted what has become a persistent disconnect between the company’s management and Wall Street over the sudden spurts in expense growth that have come from boosting capacity at Google and ploughing money into longer-term bets.

“An area we’d like to see is better cost predictability,” said Hari Srinivasan, a senior analyst and portfolio manager at Neuberger Berman, an Alphabet investor. Along with a lack of disclosure about the performance of individual parts of the business, particularly the video site YouTube, this has prevented Alphabet from getting the recognition on Wall Street that its booming business deserves, he said, adding: “The company is not being valued at the growth rate it offers.”

However, speaking on a call with analysts late on Monday, Ruth Porat, chief financial officer, said that Alphabet continued to believe that the payback from a jump in costs would be justified. “We’re very focused on investing for the long term. As a result, quarterly growth can vary — and has varied,” she said, adding that “the strength and vibrancy” of Google’s business was reflected in the fact that it had increased its revenue by about $25bn over the past 12 months, to $150bn.

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In the third quarter, Google’s advertising business drove Alphabet’s net revenue up by 20 per cent, slightly topping Wall Street expectations. The latest figures reflected the launch of new advertising formats, as well as continued strong growth in mobile searches and YouTube.

The net revenue performance also benefited from more moderate growth in traffic acquisition costs, as Google benefited from a higher percentage of traffic from its in-house websites. It also passed the one-year anniversary of a new deal with Apple that had boosted the amount it paid out to reach users on the iPhone. As a result, traffic acquisition costs rose only 14 per cent, compared to the growth of more than 22 per cent seen in the first quarter of the year.

However, profits fell well short as the company recorded another jump in costs and cut $1.5bn from the unrealised value of its equity investments. At $10.12, earnings per share were down 23 per cent from the year before, and $2.25 a share below Wall Street’s expectations. Alphabet said that $1.47 a share of that was due to the loss on equity securities, as well as the reversal of a performance fee.

The costs of investing in new buildings and computing capacity to handle expected growth at Google were one of the biggest factors behind a 23 per cent jump in Alphabet’s direct costs, pushing down its gross profit margin. Ms Porat also pointed to the higher costs of acquiring content for its YouTube television subscription service, in a market where Google is facing new competition in video streaming from rivals such as Apple and Disney.

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General and administrative costs also jumped, rising almost 50 per cent, to $2.6bn, with more than $500m of the increase related to the settlement of a tax case in France.

Alphabet had warned earlier in the year of further big increases in headcount, partly as a result of acquisitions. The company added 6,450 employees in the quarter, taking the total additions over the past 12 months to almost 20,000 and lifting its total headcount to more than 114,000 people.

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