Google's Future Continues to Depend on Mobile Ads

Updated from 8:15 a.m. to include analysis from eMarketer in the sixth and seventh paragraphs.

NEW YORK (TheStreet) –– Google (GOOG) earnings will continue to be dependent on cost-per-click (CPC), and whether advertisers begin to understand the benefits of advertising on mobile devices sooner rather than later.

CPCs, a key advertising metric, remained flat in the first quarter, when Google reported non-GAAP earnings of $6.27 a share on $12.19 billion in revenue, excluding traffic acquisition costs (TAC). Though that may indicate the company's initiatives to bundle advertising buying on various platforms is working, CPCs still fell 9% year over year.

Paid clicks, which include clicks related to ads served on Google sites and the sites of its Network members, increased approximately 26% year-over-year, but fell 1% sequentially.

Google I/O Recap: What Wall Street Thinks

On the earnings call, Nikesh Arora, Google's Senior Vice President and Chief Business Officer noted CPCs will start to move higher as more advertisers begin to understand mobile devices. He noted that in the medium-to-long term, mobile ad pricing will be better than desktop because you know more about the user and the context of what they're doing and searching for. Additionally, Google is working to making its payment enabling system easier, which should cause CPCs to rise. However getting advertisers to focus on the mobile side as opposed to desktop is a much harder initiative, and will take some time.

For the second-quarter, earnings are expected to fall sequentially, though analysts are largely bullish on Google for the remainder of 2014. Analysts surveyed by Thomson Reuters expect Google to earn $6.26 per share on $15.62 billion in revenue, including TAC. For all of fiscal 2014, analysts expect the company to earn $26.80 a share on $66.04 billion in sales.

Google continues to dominate the digital ad spend market, making mobile ads that much prevalent for Google's future. According to research firm eMarketer, Google accounted for 31.9% of digital ad spending worldwide last year. Facebook (FB) was next, accounting for just 5.8% of ad spend of the $120.05 billion market. The research firm estimates that the market will increase to $140.15 billion in 2014.

By contrast, the mobile ad market is much smaller, at just $17.71 billion in 2013 according to eMarketer, but Google is the clear leader here as well, accounting for more than 50% of the market.

Google no longer has Motorola Mobility to drag down its results (the company sold it to Lenovo earlier this year), but it is increasingly getting involved in how devices that run its Android operating system look, which may be a key issue on the company's earnings call.

At Google's developer conference, Google I/O in June, the company showed off a new version of Android, dubbed Android L, which will have 64-bit compatibility, and will feature a new user interface named Material Design that will allow developers to make color, typography and grid changes across their apps. In addition, the company also announced Android L's ART performance, which will allow the operating system to support chipsets that use ARM Holdings' (ARMH) intellectual property, Intel's (INTC) -x86 chipsets, as well as chips from MIPS.

Google didn't limit Android discussion to just smartphones, touching on the company's operating system for wearable technology, Android Wear. In addition to talking about the operating system itself, Google showed off several smartwatches that use the company's operating system, LG's G Watch, Samsung Gear Live, and the Moto360.

Aside from the core results, analysts may ask questions on some of Google's other projects, including the recent purchase of Titan Aerospace, YouTube, the future of Google Glass, and perhaps Google Fiber, the company's high-speed Internet and television plan.

Going on the earnings print, analysts are largely positive on Google. Here's what a few had to say.

SunTrust analyst Robert Peck (Buy, $680 PT)

"We expect generally in-line EPS/net revenue of $6.10/$12.3B (consensus $6.24/$12.3B), with: core gross ad revenue of $14.1B (+2% q/q, +17% y/y), paid clicks +26% y/y (from +26% in 1Q), and CPC y/y growth -7% (from -9% in 1Q). While we expect inline results, we think investor expectations are subdued with questions around the Finance ad vertical, YouTube revenues, and recent investments & acquisitions. We think the lack of overly-exuberant expectations helps provide support for the 2Q report. Further, we expect continued upbeat commentary around PLAs and Android/Play."

Deutsche Bank analyst Ross Sandler (Buy, $625 PT)

"Similar to most quarters over the past three years, we expect Google's results to largely meet but not dramatically exceed consensus estimates, which should be fine at 20x 2015 EPS. Checks have been largely in-line in 2Q, with solid growth in most regions, consistent with the consensus $6.8B domestic and $8.86B international estimates. Gross margin may flatten out for the first time since 1Q11, and we are expecting modest decline (160bps) in EBITDA margin to ~49%. We expect interest income to shave off around $0.25 of EPS Q/Q as the realized gains from Nest don't recur, for EPS of $6.19. New disclosure around O+O vs. Network clicks/CPCs should help sentiment and visibility, and we could see modest upside to our +5.8% Y/Y network revenue estimate."

Cantor Fitzgerald analyst Youssef Squali (Buy, $630 PT)

"We expect Google to report good 2Q:14 results on Wednesday, 7/17, driven by continued strength in Search and Display, particularly in the U.S., with tailwinds from Enhanced Campaigns, PLAs, programmatic and video helping it outpace growth in the ad market. Capital intensity and margin deterioration remain long-term concerns, however. We maintain a BUY rating and $630 PT."

Credit Suisse analyst Stephen Ju (Outperform, $742 PT)

"While we believe investor attention has been focused primarily on YouTube as Google's next multibillion dollar opportunity, we submit that Google Play has grown over the last two years from essentially zero to a level equal to YouTube in size and should contribute ~$4.4 billion in revenue this year. Given that this segment is buried within Google's Licensing and Other revenue line and also as the main drivers of its growth are overseas, it has not received as much attention, but we highlight it in this report as we believe it is also currently growing much more rapidly (versus YouTube) and will ultimately contribute higher operating profit and free cash flow dollars given the lower cost to operate. We increase our bottom line estimates for 2015 and beyond as we layer in greater profitability estimates as a result, and our target price increases to $742."

-- Written by Chris Ciaccia in New York

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