Google’s first-quarter results provided continued evidence of the firm’s wide economic moat at work. Quarterly advertising revenues excluding payments to publisher partners (ex-TAC) grew to $8.9 billion, 16% more than last year, greater than estimates for growth in digital advertising. However, Google operating income (excluding Motorola Mobility) grew less than 11% versus 2012.
Notably, analysts believe the economics of Google’s Internet desktop search business are not sustainable as users continue to shift to mobile computing. While the traditional desktop Internet business is generally mature and open, the mobile Internet business involves a greater number of players that have some control over the users, including handset manufacturers, wireless carriers, and application stores.
As a result, analysts expect traffic acquisition costs to increase over time as the revenue mix shifts toward the mobile segment. Google’s distribution traffic acquisition costs in the quarter grew to 7.9% of revenues generated from Google properties versus 6.4% in the prior year. We believe this trend is likely to continue.
Commentary on the earnings call should provide clarity into Google’s view on capital allocation, and investors should carefully consider the economics of new businesses. Management emphasized that the company will pursue growth in areas where it believes Google can succeed, even if the margin profile of that business is lower than its core businesses. Clearly, these investments can generate shareholder return, and most analysts believe they do.
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