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Alex Cho

Google's Decelerating Growth Metrics are Somewhat Troubling

Analysts remain pretty optimistic on Alphabet/Google, but there’s no denying the deceleration in search metrics despite the transition to mobile. It’s not yet clear, but initial channel checks imply a modest drop-off in y/y growth comps to Q1’16 results, as the company’s going through an adjustment phase following the loss of the Mozilla contract, and an on-going transition towards ad-unit limitations whereby the right hand rail i.e. banner ads were removed in exchange for larger ad units at the top of search results (bigger lettering and even product listing ads).

I believe analysts were anticipating stronger pricing for ad-inventory given the reduction to inventory, and improvement in ad conversions. But, as we had witness in the prior quarter, those trends didn’t actually materialize, which is why there’s a lot of uncertainty among the institutional managers as it’s one of the least predictable companies going into earnings.

That being the case, the analysts at Morgan Stanley got into the nittier grittier details as to why they’re revising estimates lower in response to channel checks and TAC:

We now expect 22% ex-FX Websites growth in 2Q:16 (vs 24% previously). We believe the biggest factor driving RKG's spend deceleration is the lapping of the increased minimum bid requirements on branded keywords introduced in 2Q:15. For perspective, RKG indicates that branded costs per click rose ~30% between 1Q:15 to 2Q:15.

I think Morgan Stanley has a pretty valid reason for lowering estimates a little going into the quarter. The trends in deceleration is fairly painstakingly obvious, and while there might be near term drivers, it’s still the long-term headwinds of declining search penetration that’s reducing Google’s growth trajectory. Furthermore, it’s well known that Google does penetrate into emerging markets quite effectively with its search product via the Android OS platform, but the incremental users don’t add up too significantly to advertising dollars given the limitations on marketing spend, and value of conversions from these developing regions.

That being the case, I still like Google, but I wouldn’t label it a top Internet holding. It’s difficult to arrive at accurate estimates prior to an earnings report, and there hasn’t been much headway in increasing cost per click or conversion metrics in the past couple years, which is why revenue is decelerating on quarter on quarter basis quite consistently.

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