Alphabet Inc. (NASDAQ:GOOGL) will report Q1 earnings on Thursday, April 27 after the market close. Expectations have softened mainly because of issues with ad placement and boycott by advertisers and the stock has underperformed this quarter (up 0.4% vs. NASDAQ up 4.6%). Impact and status of resolution will be a primary focus of investors, as will TAC rate to distribution partners as rate escalation here is expected to moderate. Status of stock repurchase will also be of interest as Alphabet was restricted last quarter. MKM Partners thinks Alphabet's position remains incredibly strong, its high growth from large numbers is impressive and it considers valuation highly attractive vs. media companies it continues to gain share against. Reiterate Buy and $1,000 PT.
Consensus for Websites revenue growth is 18.6%, a deceleration from 20.3% last quarter. The firm thinks this is achievable and could be slightly better. Consensus for core Google operating margin appears to be down about 75bps y/y on a nonGAAP basis. Last quarter, management disclosed one-time charges of $320mn to gross margin, but would not clarify whether this was related to Google or Other Bets. There will be no non-GAAP reconciliation tables for the first time this quarter as the company has fully moved to GAAP reporting. Depending on how much or little color the company does provide in segment reporting, this could be a source of confusion.
Issues and media attention started in the U.K. (a 9% region for Alphabet), then spend modestly to the U.S. YouTube and Google Display Network are most effected and likely around 25% of total revenue. Advertisers did not alter their search spending. If related ad spend in the U.K. is pinched by 10%, this would be $16mn to $17mn per month. As brands started pulling back in mid-March, MKM thinks the potential impact to Q1 is likely immaterial. The boycott seems to be well contained by this point and Alphabet is addressing issues. In its scenario above, a full quarter impact could be a $50mn drag on Q1, about a 0.2% of the firm’s ad revenue forecast for the quarter.
O&O TAC jumped in Q1’16 and has been trending higher since. Investors believe the step-up was caused by a renewal to distribution partners (i.e. Apple, Samsung). If so, the rate of TAC escalation should moderate in Q1. If not, investors will likely grow concerned about greater than modeled deleveraging as the shift to mobile continues. Consensus is for 10.1% O&O TAC, about 160bps higher than a year ago and less than the 185bps increase last quarter.