Monday, September 3, 2012

Google vs. Facebook Over Mobile

The market liked the recent results from Google $GOOG and in many ways the company’s strategy is being better understood. It is ironic that it took the Facebook $FB IPO in order to truly focus the market’s attention on the seismic changes that are happening in internet usage. While it is highly debatable whether Facebook has a coherent strategy for mobile, few people can question that Google is not leading the way in adapting to the new mobile reality. Google faces a number of challenges with mobile related issues, and understanding them is critical to any investment appraisal.

Integrating Motorola Mobility

The most apparent issue is the integration of Motorola Mobility. This was the first quarter in which its numbers were included in Google’s reporting. Analysts wasted no time in questioning when it would no longer generate losses, but the answers seemed quite non-committal. Perhaps it’s understandable in that Google’s team has only had a few weeks in charge, but buying a business without a clear pathway to profitability is a sign that this acquisition is seen as a kind of ‘loss leader’ for the core part of Google’s advertising offering.

The challenge here is that –while the Google name is synonymous with mobile technology- it has not had demonstrable success with hardware.  Investors would be right to view the integration with caution. However, I think it is better to view Motorola as part of the integrated way that Google runs it strategy.

Google’s Mobile Strategy

According to most industry statistics Google’s Android has a majority share of smartphone operating systems. In addition, Google has almost all of the mobile market for search. This dominant positioning in mobile is the key to Google’s overall offering.

Advertisers and marketers want their brand management to work and achieve leverage wherever consumer interaction takes place, therefore it is essential that campaigns be integrated and analyzed over a range of platforms. This means that Google has an increasingly strong position with advertisers because it offers a pathway to monetizing mobile. Moreover, Google Analytics gives companies the capability to better generate and monitor return on investment in campaigns via an integrated approach across various sales channels.

Google is well placed in analytics but faces fierce competition in the analytics market from IBM $IBM and Adobe Systems $ADBE Google offers much of its analytics for free, but Adobe has a strong relationship with digital marketing via its publishing software and IBM has an integrated offering for corporations.

Putting these strands together, the Motorola acquisition gives Google a hardware component in which to experiment and secure positioning for Android. In turn, the operating system gives Google future revenue potential and a de-facto monopoly over search. Google Analytics lets companies analyze and integrate Google into their marketing activities across all platforms. All of which lead to revenues in the core activity of advertising.

Google Adjusting to Mobile Realities

In order to demonstrate the changes here I want to share some data graphically.

It is not hard to see what the market is worried about. As internet usage increasingly shifts to mobile and tablet usage, Google has had to adjust the way it does business. Cost per click has seen a dramatic decline, while the increase in paid clicks has been similarly dramatic. Overall revenue growth has been moderating but from extremely high levels. It’s easy to forget that Google is achieving 20%+ revenue growth while generating huge amounts of cash flows.

Frankly, I don’t think this is as much of an issue as a lot of the media makes it out to be. Google explained that currency effects (stronger dollar) had an effect, as well as a conscious shift to increasing paid clicks at the expense of cost-per-click.

An example of this is the increase in site links. These are the individual links to various parts of a website that appear after a search. While they are great for encouraging interaction with a site and therefore increase paid clicks, I suspect they do generate less cost-per-click. This is not a problem as long as overall revenue increases in the mix.

As for the issue of increasing mobile ads, this too, should not be seen as a particular issue. Smartphone internet usage is definitely different but probably involves more focused search (via engines) and re-occurring visits to favorite websites (Facebook, Youtube) than the meandering browsing experience of sitting in front of a pc. There is every reason to expect that Google will be able to continue to generate growth even as internet usage shifts to mobile & tablet from pc.

The key thing is that Google is recognizing the need to adjust to this reality, even if it is putting pressure on cost per click metrics.

Geographic Expansion Opportunities are Underestimated

I think the geographic opportunity is vastly underestimated by many investors. The argument is that penetration in the Anglo-Saxon countries is a precursor to the kind of rates that Google can expect on a worldwide basis.  For example, US revenues make up around 46% of the total and the UK makes up about 20% of international revenues.  For linguistic and cultural reasons, it’s natural to expect these regions to lead the way, but I will be amazed if these ratios stay the same in five years time.

There is no reason why English speaking countries shouldn’t catch up with the Anglo-Saxon world in terms of e-commerce and digital marketing activities. This argument applies to domestic advertisers but, critically, it also applies to the international campaigns of global advertisers.

If you think about it, the huge amounts of data being generated by social networks such as Facebook or Google+ are going to change the way marketers can target consumers. It will lead to more focused campaigns that can be tailored to suit localized consumers in a highly differentiated way. This means that online advertising can be better targeted and that revenues in the less developed markets have huge potential for future growth.

What Next For Google?

Google really needs to carry on executing and experimenting in order to find the perfect way to manage the shift to mobile. Investors often want jam today, but Google is managing to deliver jam while also working on new recipes in mobile. So far, so good, but the Motorola acquisition will remain a question mark and analysts will be watching new handset development very keenly.

I think the long term picture is extremely positive for Google.  Expansion of international revenues is likely to lead to very strong growth in the future and investors should respect that if anyone can monetize mobile successfully it will be Google. The stock offers growth drivers that are a lot less cyclical than so many other companies, and I think it offers good value too.

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