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source from：barron's
Digital Ad Growth, YouTube Will Lift Alphabet 20%
Google plays catchup in cloud services, helped by artificial intelligence and machine learning.
By JACK HOUGH
January 21, 2017
Watch for two key milestones for advertising this year. Digital venues will overtake television as the top draw for ad spending. And mobile, for the first time, will make up more than half of digital.
That bodes well for companies that pull in massive audiences online, especially over smartphones. In the U.S., two stand above all others: Facebook (ticker: FB) and Google parent Alphabet (GOOGL). Together, they control 54% of digital advertising, up from 44% a year ago. We recommended shares of Facebook five months ago, a few bucks below where they recently traded. Now it’s time for a fresh look at Alphabet, whose shares look likely to top 1,000 dollars in a year, for a gain of over 20%.
In 2017, digital ads will bring in 202 billion dollars—40% of all ad spending, according to industry forecaster Magna. That compares with 36% for television. It’s just a start. Digital spending will continue soaring and will capture a 50% share by 2021, while TV spending will barely expand and its share will shrink to 33%.
If “digital” brings to mind just banner ads, it shouldn’t. Spending on those is expected to decline for the first time this year. Nearly all of the recent growth in digital ads has come from search and social media, especially social videos, and small screens are playing a big role. Mobile will reach 52% of digital ad spending this year, according to Magna. By 2021, mobile’s share will balloon to 72%.
Alphabet is ready. It owns the world’s leading search business in Google, along with the top operating system for mobile phones, Android, which helps give Google a dominant share in mobile searches. YouTube, we have argued, is the world’s most valuable video streaming service (“Why YouTube Is Twice as Valuable as Netflix ,” Dec. 26, 2015).
YouTube quietly makes Alphabet a major player in social media. There’s also DoubleClick, an ad service; the Nexus line of phones and tablets; the Chrome browser and notebooks; and a promising cloud-computing business.
Last quarter, Alphabet’s revenue grew 20%, year over year, to 22.5 billion dollars; in constant currency, the increase would have been 23%. That’s an acceleration from already brisk growth a year earlier: 21% in constant currency.
In discussing results with analysts, management called out “strength” in mobile search, “decent growth” on desktops and tablets, and “very significant” growth from YouTube. Much of YouTube’s recent success has come from two Alphabet tools working in tandem: TrueView, which allows users to close video ads after five seconds—it has become a favorite of marketers, who get a few seconds of free attention from everyone and are willing to pay dearly for users who watch their ads willingly, rather than grumpily—and DoubleClick Bid Manager, a programmatic ad service that marketers can use to let machines pick appropriate videos for their messages.
A FEW NEW TRICKS could make 2017 another year of brisk growth. The most important takes full effect at the end of this month. Alphabet has redesigned its paid search text ads to give fuller descriptions and look better on mobile. That should increase click-through rates. It also has bumped up the number of paid results it shows for lucrative search terms. And device bidding allows marketers to better target desktops, tablets, or smartphones.
Product listing ads, with photos and pitches for specific goods, have migrated from Google Shopping to new destinations, like image searches, YouTube, and third-party Websites. Promoted pins in Google’s popular maps service allow local advertisers to reach out to potential customers who are passing by. Changes like these suggest that the rates advertisers are willing to pay for mobile ads gradually will rise toward what they now pay on desktops. What mobile lacks in screen size, it will increasingly make up for in scale and targeting.
This year, Wall Street expects Alphabet to report total revenue of 85.4 billion dollars, up 17%, and earnings of 23 billion dollars, up 18%. That includes the cost of stock-based compensation, which could total 8 billion dollars this year after a hiring spree in 2016. Adjusted for stock comp and a related tax benefit, earnings are expected to total 29 billion dollars, up 20%. Adjusted earnings per share are pegged at 41.20 dollars, up 19%.
That puts Google shares, recently 828 dollars, at 20 times earnings. The Standard & Poor’s 500 index is priced at about 17 times operating earnings. But there’s a crucial difference. In recent years, S&P earnings estimates have tended to start the year far too high and get trimmed as each quarter approaches. Alphabet’s 2017 earnings estimates, on the other hand, have been rising. At 1,000 dollars, shares would go for less than 21 times their 2018 adjusted earnings estimate.
THE STOCK IS UP more than 50% since Barron’s recommended it two years ago (“Google: Time to Buy the Stock,” Dec. 6, 2014). But it slept through last year, rising only 2%. One thing holding it back might be its lowish tax rate, around 20%. Republicans in Congress are expected to slash corporate tax rates but scrap many deductions, so it’s conceivable—though not quite likely—that Alphabet will end up paying more. But with cash and investments of 83 billion dollars, of which 60% is held overseas, the company stands to benefit from a break on repatriation taxes.
Falling profit margins are a bigger concern. Google pays Apple (AAPL) for preferential search treatment on the iPhone and shares its YouTube winnings with popular video submitters. As mobile and video outgrow the rest of the business, margins could come down slightly. But Alphabet also can cut costs, especially in its Other Bets division for emerging businesses.
One business to watch is Google Cloud Platform. The overall public cloud market had revenue of 32 billion dollars last year, which could rise to 85 billion dollars by 2020, according to JPMorgan analyst Doug Anmuth. Amazon.com (AMZN), which controls 80% to 85% of the market, has proven that the public cloud is no mere commodity service, but one capable of delivering plump profit margins. Microsoft (MSFT) is the No. 2 player, with a 10% to 15% share. Alphabet has only 5% or so, but is making the public cloud a bigger focus by opening more data centers and using its expertise in artificial intelligence and machine learning to create services that go beyond simply renting space on servers. It’s a big opportunity with low expectations, and thus a potential source of upside for future results.
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