Alphabet Earnings: What to Watch

By Jack Nicas Features Dow Jones Newswires

Google parent Alphabet Inc. is scheduled to announce third-quarter earnings after the market closes Thursday. Here's what you need to know:

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Earnings forecast: Alphabet is expected to report per-share earnings of $8.31, according to analysts polled by FactSet, compared with $9.06 on that basis a year earlier.

Revenue forecast: Analysts expect revenue of $21.93 billion excluding payments to advertising partners, compared with $18.27 billion on the same basis in the year-earlier period.

WHAT TO WATCH:

-- TAC: The fees Google pays to distribution partners -- called traffic acquisition costs -- have been steadily rising in recent years, swallowing up a bigger share of its revenue. Google pays the fees to keep its search engine and other apps front and center on smartphones made by other companies, and analysts attribute the recent TAC increase to pricier contracts with Apple Inc. Google paid those distribution partners $2.05 billion in the second quarter, or 11.1% of the revenue from Google websites -- up from 7.6% two years prior. Analysts expect those distribution fees to increase to $2.37 billion in the third quarter, or 12.3% of Google sites' revenue. Google's total TAC, including payments to third-party sites where it places ads, is expected to increase 25% to $5.24 billion from $4.18 billion a year prior. Investors are watching TAC closely to see if it will continue to eat up more revenue. Some analysts warn potential regulatory action in Europe could further increase TAC by forcing Google to pay Android phone makers more to promote its services.

-- MARGINS: While Google's ad operation continues to be a robust and stable business, Google's net operating margin has declined year-over-year for four consecutive quarters. Excluding the loss-making "other bets" segment of Alphabet -- and the impact of a $2.7 billion fine from the European Union -- Google's net operating margin declined to 37.7% in the second quarter from 40.3% a year prior. It could dip again in the third quarter: Mark Mahaney of RBC Capital Markets estimates a 36.5% margin, down from 37.5% a year prior. The shrinking margins are in part because of increasing TAC and growing investment in YouTube and its Google Cloud business, two major bets for its future. "Although Alphabet's revenue is growing at a healthy rate, growth areas are increasingly coming from lower margin businesses like mobile search and programmatic, putting increased pressure on profits," eMarketer analyst Martin Uteras said in an email.

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-- OTHER REVENUES: Google is eager to build another booming business alongside advertising, and its main bet to do it is via the cloud. Google is battling with market leaders Amazon.com Inc. and Microsoft Corp. to sell computing power and storage over the internet to corporations. Revenues from its cloud division are wrapped into its "other revenues" segment, along with sales of apps and its new hardware devices. Investors watch that segment for signs of progress in its cloud effort -- and its renewed push into hardware, which is more likely to show movement in the fourth quarter, with the launch of new products. After "other revenues" increased by 42% in the second quarter to $3.09 billion from a year prior, analysts expect the segment to grow by 39% to $3.39 billion in the third quarter.

(END) Dow Jones Newswires

October 25, 2017 05:44 ET (09:44 GMT)