Escalating costs see Google’s Alphabet operating margin shrink

Escalating costs see Google’s Alphabet operating margin shrink

Investors are uncertain about future profit at Alphabet as the company navigates the move to a phone-based computing

Sundar Pichai - CEO, Google

Sundar Pichai - CEO, Google

Strong growth in ad sales on Google search and YouTube were not enough to offset a surge in costs at parent company Alphabet that shrank the first-quarter operating margin, leaving shares flat after hours on Monday.

Alphabet got a boost from how it values investments in Uber Technologies and other start-ups. That accounting change and a one-time benefit cut its effective tax rate nearly in half.

Investors are uncertain about future profit at Alphabet as the company navigates the move to a phone-based computing world and invests in small, fast-growing initiatives from self-driving cars to selling hardware and cloud computing services. The quarterly results did not clarify the outlook.

Alphabet's operating margin of 22 per cent, down from 27 per cent a year ago, missed expectations because of the growth in expenses.

Alphabet is investing to keep pace with Inc and having to share more of its revenue with phone and browser makers, said James Cordwell, analyst at Atlantic Equities.

"The jump in profits is purely due to one-time items," he said.

Longer-term capital expenditures nearly tripled to US$7.3 billion in the first quarter from US$2.5 billion a year ago.

Still, worldwide sales increased to US$31.1 billion, above the average analysts' estimate of US$30.3 billion, according to Thomson Reuters I/B/E/S.

Those ad sales showed investors that there were no immediate signs that rising global privacy concerns had affected profits, even as concerns over Facebook Inc's use of privacy cast some suspicion on Google.

Officials across the world seek to force changes in Google's business practices, such as giving customers more control over their data.

"The strong economy has companies spending more on advertising," said analyst Ivan Feinseth from Tigress Financial Partners. "Google continues to dominate both mobile and desktop search”, and that there will be "very little effect" from Facebook privacy data fallout, he said.

Google Chief Executive Sundar Pichai told analysts Monday that, "It's important to understand that most of our ad business is search, where we rely on very limited information, essentially what is in the keywords to show a relevant ad."

Start-up investments boost profits

Alphabet's quarterly profit of US$9.4 billion, or US$13.33 per share, exceeded estimates of US$6.56 billion, or US$9.28 per share, according to Thomson Reuters I/B/E/S.

About US$2.4 billion in earnings were attributable to a new accounting method for unrealized gains in Alphabet's investments in startups such as Uber and Airbnb Inc.

Alphabet now records estimates of the current value of its startup investments rather than waiting to report income once it has opportunity to sell those shares.

That change and a one-time benefit drove the effective tax rate in the quarter to 11 per cent from 20 per cent a year earlier.

Excluding the investment-related gains and other items, adjusted earnings were US$9.93 per share.

Google had several one-time costs including acquiring 2,000 employees in Taiwan for US$1.1 billion from HTC Corp and moving up when it awards equity to employees.

Continuing cost increases came from acquiring streaming rights for YouTube's new TV service and marketing new products.

Google executives say the spending to install powerful computers and internet cables is necessary to keep up with demand for YouTube, its Google Assistant virtual helper service and data analytics tools within its Google Cloud services.

Revenue from Google's non-advertising units was US$4.4 billion in the first quarter.

Alphabet is paring back on "other bets," a set of ancillary projects in areas such as medical technology and drones. Operating loss from "other bets" fell to US$571 million, from US$703 million a year ago.

Investors are counting on one other bet, the Waymo self-driving vehicles effort, to generate noteworthy revenue this year as it begins offering ride-hailing services.

Google revealed smart thermostat maker Nest generated about US$726 million in revenue in 2017, above some analysts' estimates. Financial results for Nest had not been released since its acquisition in 2014.

(Reporting by Paresh Dave and Arjun Panchadar; Editing by Lisa Shumaker and Peter Henderson)

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