Lower mobile click fees and rising compensation costs trouble, but Nest, Titan Aerospace acquisitions excite

Excluding its soon-to-be-departed money-losing smartphone brand -- Motorola Mobility -- Google Inc. (GOOG) posted a net profit of $3.45B USD (GAAP), up from $3.35B USD in Q1 2013.  For the quarter Google pulled in revenue of $15.42B USD -- roughly $100M USD less than the $15.54 that Thomson Reuters I/B/E/S expected.

I. Rise in TAC Continues, Mobile Monetization Outlook is Mixed

Google's "traffic acquisition costs" (TAC) -- money it shares with its partners including browser makers who use Google Search as their default search engine and internet sites that displays ads vended by Google's network -- rose to $3.23B USD from $2.96B USD in Q1 2013.  But that number was better than it sounds as TAC accounted for only 23 percent of the revenue for the quarter, versus 25 percent a year prior.

Excluding those costs, Google had revenue of $12.2B USD -- less than the $12.3B USD that analysts surveyed by Bloomberg were expecting, on average.

Google sign wide
[Image Source: Gullf Business]

One key trend that has Google shareholders concerned is a fall in revenue per click due to the fall in desktop clicks and explosion of mobile ad clicks.  However, given that Google grew its ad clicks by a bullish 26 percent versus Q1 2013, the good news is that growth in click counts appears to be outpacing the fall in revenues for now.

So if it wasn't TAC or falling ad revenue, what did damage Google's revenue?

One hit came from stock-based compensation (SBC), which rose from $655M USD in Q1 2013 to $839M USD in Q1 2014.  Google is wooing a lot of top talent, and stock options are a key incentive.  Among its key hires last year included Blaise Agüera y Arcas, the genius behind Microsoft Corp.'s (MSFT) Photosynth, and Ray Kurzweil, a futurist inventor who is participating in Google's robotics project.

BGC Partners, Inc. (BGCP) analyst Colin Gillis comments to Reuters:

It's an average quarter from a great company.  It's the same old story. Paid clicks were a little lighter than people might have hoped, CPC declines were a little higher than people would have liked, expenses continued to rise.

Many voiced similar reactions to the earnings report.
II. Nest: A Steal?
But there were also strokes of potential brilliance in Google's Q1 2014 execution, which may play a crucial role to Google's long-term revenue prospects.
Google continues to make big investments -- both in proven startups and in speculative future tech firms.  It bought former Apple, Inc. (AAPL) iPod-father Tony Fadell's new firm, Nest for $3.2B USD.  Nest makes smart home products, including its wildly popular learning thermostat.  It already had Google ties, thanks to its large number of former Google engineers in its ranks.

Nest Labs Learning Thermostat

The deal was marred by an embarrassing halt in sales of Nest's new smart smoke alarm, which was revealed to be accidentally disabled by hand wave gestures -- a feature gone awry.  Still Morgan Stanley (MS) analyst Scott Devitt suggested the $3.2B USD purchase was a steal.  He claimed in a recent research note that Nest was selling 100k+ thermostats per month and on pace to generate revenue of $300M USD in 2014.  
While the average multiple for digital space acquisitions is closer to 3x revenue, for fast-growing hot properties, 10x revenue is considered a pretty affordable buy.  For example, Facebook, Inc. (FB) a sometimes rival, sometimes ally of Google paid an incredible 950x for Whatsapp.  The mobile messaging firm reportedly made $20M USD in 2013, but Facebook paid $19B USD for it ($16B USD in cash and stock, and addition $3B USD in restricted stock), admiring its growth potential and strong position in the messaging market.
III. Titan Aerospace and "the Next Billion"
Google also paid an unknown amount just weeks ago for UK drone maker Titan Aerospace.  Google is racing Facebook (who also made recent drone acquisitions) to deploy solar-powered drone servers to provide internet coverage to remote regions.  Google teased at such efforts with Project Loon -- an internet balloon scheme.
Why are Facebook and Google so keen on this?  Well, according to estimates, roughly two thirds of the world's population does not have access to reliable internet.  That's a lot of potential customers, and a lot of potential money to be made, for the company or companies that can figure out how to affordably connect those customers.
Titan's massive high altitude, lightweight solar drones should provide a literal and metaphorical boost to such efforts.  Titan holds the record for longest time aloft for a drone; it claims its latest and greatest designs are capable of staying in flight five years before touching ground.

Titan Drone

In a statement, Titan disclosed some of Google's plans for it, writing:

Titan Aerospace and Google share a profound optimism about the potential for technology to improve the world. It’s still early days, but atmospheric satellites could help bring Internet access to millions of people, and help solve other problems, including disaster relief and environmental damage like deforestation.  It’s why we’re so excited to welcome Titan Aerospace to the Google family.

Titan is expected to be integrated into Google's robotics unit, which is being led by former Android CEO and cofounder Andy Rubin.  Google also signed a deal this quarter to test some of its factory robots with Hon Hai Precision Industry Comp. Ltd.'s (TPE:2317) subsidiary Foxconn.  Foxconn has expressed a strong desire to replace some of its disgruntled Chinese workforce with robots, but has struggled with such efforts.  For Google, which is reportedly designing smarter, safer factory robots, this is a brilliant opportunity.
Google -- like Microsoft -- also is continuing to grow its sales music, app, video, and hardware sales, which fall under its "other" revenue category.  This category grew by a whopping 48 percent on a year-to-year basis to reach $1.55B USD.
IV. Motorola Mobility Sale Allows Google to Refocus on its Market Leading Tablet, Smartphone Platforms
Certainly Google can't be faulted in its mobile operating system efforts.  Its Android operating system is the world's top tablet operating system, accounting for roughly two out of every three tablets sold, and the most used smartphone operating system, accounting for roughly four out of every five smartphones sold globally.
Google is in the process of closing its relationship with Motorola Mobility, which lost $198M USD for the quarter, an improvement for the posted loss of $271M USD from a year prior.  Motorola made $1.45B USD in effective revenue for the quarter, up from $1.02B USD.

Lenovo Group Ltd. (HKG:0992) -- a phonemaker with a maturing Android smartphone project already -- announced its intent to purchase Motorola Mobility in late January 2014.  The deal -- worth $2.91B USD -- will also transfer roughly 2,000 of Motorola Mobility's 17,000+ patents.  The remainder of the patents will stay with Google, as will Motorola Mobility's Advanced Technology Group, which is working on advanced concepts such as the Ara modular smartphone and novel NFC password devices (e.g. epidermal password tattoos or ingested password pills).
Google had bought Motorola in a controversial 2011 acquisition for $12.5B USD.  In 2012 it tried to downplay the importance of patents in the purchase, but the structure of the sale lends credence to the notion that the purchase was largely to gain an intellectual property stronghold in the smartphone space, a space that Google is a relative newcomer to, despite its dominant position.

Android Moonshine
The reported Moonshine makeover [Image Source: Android Police/Imgur]

Google launched Android v4.4 Kit Kat in Oct. 2013.  A new release with an updated UI with flatter icon designs (dubbed Project Moonshine) is slotted for sometime this quarter, possibly under the name Android v4.5 or Android v5.0.

V. Future Niches

Outside of Android Google continues to gain ground in the budget laptop market with its Chrome OS, which is thought to account for as many as 1 in 5 budget laptop sales.  Market analytics firm ABI Research indicated that 2.1 million Chromebooks were sold in 2013.  The firm writes:

ABI Research tracked Chromebooks across 6 regions and found the ASP to be $338.  This truly budget-driven device is a disruptive force to the portable PC market.

Google is also eyeing an assault on the low-power/compact PC market, with its "Chromeboxes" -- Chrome OS desktop computers.
Google is also currently the first major platform provider to leap into many wearable niches.  It announced its Android Wear operating system earlier in mid-March, but has struggled to convince OEMs to adopt it.  So far Motorola Mobility has been the only major Android OEM to pledge to embrace the new Google platform in its wearable offerings (most OEM partners currently use in-house proprietary solutions).  Motorola Mobility may tempt others to make the switch, though, given the strong reaction to the Android-powered Moto 360 smartwatch concept, which is expected to be productized shortly.

The Moto 360, powered by Android Wear

And Google Glasses continue to both fascinate and ignite controversy.  

Google Glasses [SOURCE: t3]

Google teased at a potential public launch this month, with a one day sale to members of the public for the Glass Explorer Edition, a device that is currently limited to developers.  Consumers could buy the Glasses computer for $1500 -- the same price developers pay.

Sources: Google Press Release, Reuters, Bloomberg

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