The one thing worrying Alphabet investors

Markets Reuters

(Reuters)

There are very few things that make Alphabet Inc's investors unhappy. A rising TAC - the cost of driving traffic to its site - is one of them.

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Google-parent Alphabet, which has enjoyed revenue growth rate of over 20 percent for the past five quarters, said on Monday that TAC, or traffic acquisition costs, jumped 28 percent to $5.09 billion in the second quarter.

That is the highest percentage increase in TAC in nine years and analysts said they expect it to continue to weigh on margins even as the company's fundamentals remain strong.

Alphabet's shares, which have surged 26 percent this year, slipped 3 percent in early trading on Tuesday.

Google relies heavily on partners such as Apple Inc , which has made Google the default search engine on the iPhone. It also pays websites to run ads.

"The company continues to cite mobile and programmatic as drivers of overall increases in TAC, which we believe will likely continue to increase in absolute terms and as a percentage of revenue for the foreseeable future," Goldman Sachs analysts wrote in a client note.

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The company has warned that spending on traffic acquisition is expected to keep rising as a shift to mobile advertising continues and programmatic advertising - in which ads are bought, sold and displayed by automated systems - becomes more important.

Traffic acquisition costs were 22 percent of advertising revenue in the second quarter. Net ad revenue rose 16 percent, compared with 18 percent last quarter.

Canaccord Genuity said it expects TAC to jump to $21.07 billion in 2017, 25 percent higher than last year. It had risen 17 percent in 2016.

"The light net ad revenue coupled with the recent run-up in GOOG's share price are likely to cause a pullback," Needham & Co analyst Kerry Rice said.

Despite concerns about TAC, most analysts remained upbeat about the company's potential to keep growing revenue and profit at strong rates.

"GOOGL's 2Q highlights the still long advertising runway and robust innovation-driven revenue growth potential (search, YouTube, cloud, etc) ... we remain longterm bulls given GOOGL's strong top-line momentum and reasonable valuation for growth," Morgan Stanley analysts wrote in a note.

The brokerage cut its price target to $1,040 from $1,050, one of at least five brokerages to do so. Google's stock closed at $998.31, not far from the median price target of $1,065.

(Reporting by Sayantani Ghosh in Bengaluru; Additional reporting by Aishwarya Venugopal and Derek Francis; Editing by Saumyadeb Chakrabarty)

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