Alphabet Delivers a Resounding Beat

 | Oct 28, 2016 | 6:00 AM EDT
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  (GOOGL) reported a solid top- and bottom-line beat with its third-quarter results after the bell Thursday, topping the high expectations that had driven the stock to new all-time highs in recent weeks. Revenues of $22.45 billion (up 20% year over year and 23% in constant currency) came in roughly $400 million ahead of consensus and EPS of $9.06 smashed consensus of $8.64. 

As we mentioned last week in our comprehensive note detailing <a href=""><b> why we have always stuck with Google</b></a>, we remain confident in the company's long-term growth, which is underpinned by savvy investments by CFO Ruth Porat in addition to continued dominance in core businesses. 

Importantly, this most recent quarter serves as a reminder never to count out the search giant even as the company approaches a round of tougher comps due to new advertising products added last year that have boosted results. We believe this quarter does the job to justify GOOGL's recent rally and demonstrates the power of the company's new, leaner operating model that boasts more visible profitability. In what has been a stark turnaround since Porat took the helm as CFO, Google has become a model of consistency, utilizing an ROI-based model to evaluate the viability and benefits of any decision. 

Digging deeper into the quarter, mobile search and video, as well as YouTube, continued to be a key driver for the company's core advertising business, indicating growing demand for the areas in which Google is investing the most. Google websites revenue (the core search business) grew a whopping 23% year over year to $16.1 billion, beating consensus expectations of $15.8 billion. Advertising revenues experienced solid growth as well, rising 18% year over year to $19.8 billion. Core Google's other segment revenues grew 39% year over year, likely resulting from explosive growth in Google's Cloud platform, which is expected to be one of the key upside drivers as Google transitions to a new era in which it will capitalize on trends outside the core business. 

Importantly, free cash flow of $7.2 billion was well above consensus of $4.8 billion. Core capital expenditures were $2.4 billion, again coming in below consensus, which called for $2.6 billion to $2.7 billion. Even better, the majority of this capital was allocated toward the core Google segment, which of course drives the majority of revenues for the company. 

As is typical with Google's releases, bears like to point toward headcount, which again grew on a sequential and year-over-year basis. That being said, Porat has already dismissed these concerns on the conference call, noting that headcount growth is seasonally highest in the third quarter, as this is when new graduates join. Consistent with past quarters, headcount grew primarily to supplement the fastest-growing businesses, such as Cloud, with new engineers and product managers, who help drive continued innovation and ensure execution. 

On some of the core operating metrics, aggregate paid clicks grew 33% year over year (and accelerated sequentially from the second quarter's 29%), crushing consensus expectations for a 26% gain. Paid clicks on Google websites grew 42% year over year, also walloping consensus expectations for a 31% gain. Importantly, total cost per click again declined more than the Street had expected, but we note that GOOGL management has consistently prepared investors for this as advertising shifts to mobile and YouTube, both of which inherently drive volume growth while driving down cost per click. 

To put the icing on the cake, management also authorized a new $7 billion share repurchase program, a key development that will serve to appease investors who were skeptical since the prior authorization had run dry. 

All in, we believe this quarter proves Google's continued dominance in its core businesses even while it pushes for growth in other key areas, such as YouTube and Google Cloud. We believe Porat's influence is deeply engrained within the company and investors are reaping the rewards. Strength in businesses outside of search will propel Google to the next era of leadership and, importantly, will allow room for further investments for the future. The combination of innovation and execution keeps this story going strong.



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