f9dc9f4f-29dc-45a7-a961-cd287b452262_Google-2019-Analysis.pdf
Google: 2019 Analysis
INTRO
Financial analysts and journalists continue to question why Google missed in Q1 2019. Without properly identifying the cause of the revenue miss, which was the slowest sales growth since Q4 2015, it is nearly impossible to predict how Google will perform in the future. Google executives offered very little on the earnings call.
“Alphabet Inc.’s growth is slowing, and analysts don’t have a clue as to why because executives aren’t talking … After releasing disappointing first-quarter results in late April, executives were vague, if not outright unresponsive, about slowing growth.” -Marketwatch, July 19th, 2019
Deciphering exactly why Google missed is impossible to prove, although we believe the quiet contention between Apple and Google on browser ad-tracking may have played a role. The Safari browser captures 58% of overall mobile traffic in the United States with Chrome capturing 33.3%. In the UK, 45% of users use Safari and Mozilla. Therefore, Google’s revenue is susceptible to Apple’s Intelligent Tracking Prevention (ITP), with tighter restrictions going into effect throughout 2019.
There is also evidence of weakening fundamentals that extend beyond any one change to the way ads are targeted and monetized. We lay out these details below.
SECTION 1: PRODUCT OVERVIEW
1A. Apple’s Intelligent Tracking Prevention (ITP 2.1 and ITP 2.2)
Launched in 2017, Apple’s Intelligent Tracking Prevention (ITP) places a limit on how long cookies are available for third-party contexts. ITP restricts cross-site tracking for targeted advertising purposes by removing cookies after 24 hours. Login cookies are available for up to 30 days, however, login cookies do little for targeting purposes as they do not track a user’s activity. After 30 days, the login cookie is purged.
When Apple first introduced ITP in 2017, it did not have an effect on Google as users of Google’s search service and other properties visit these sites daily. ITP 2.0 was aimed towards third-party trackers, such as Criteo and Doubleclick. Some critics state ITP strengthened Google as one of few remaining options to target niche audiences at scale.
Apple continued to battle data collection on the Safari browser in 2018 by shutting down finger printing, a method of triangulating who a user is through fonts, screen dimensions and plugins.
We’ve seen statistics from publishers where they get half the CPM value as a result of ITP’s impact. If they can’t have good targeting, some of their sites become less worthwhile for their advertisers.” – Google, CES 2019
In March of 2019, Apple announced ITP 2.1, which prevents third-party cookies from being stored as first-party cookies. This update also puts a limit on how long first-party cookies can be stored of up to 7 days. To put this in perspective, a Google Analytics cookie, in theory, would last for up to two years. Safari can now delete it within 7 days.
The final hammer was dropped in May of 2019, when Apple announced ITP 2.2. This update is intended to limit any workarounds by limiting all tracking to 24 hours. This includes Google and Facebook. The result will be weakened attribution, which in turn, lowers CPMs due to weakened ad targeting.
Here’s a description from Digiday that puts into context how ITP 2.2. works:
“ITP 2.2 cuts the first-party cookie’s lifespan from seven days to one day. As a result, the first-party cookies that Facebook and Google have introduced in order to continue measuring site traffic and attributing ads will be deleted after 24 hours. As a result, if a person clicks on an ad for a product on Friday and decides to take the weekend to think about buying, then the cookie wouldn’t be around on Monday to register when the person returns directly to the site to buy the product.” -DigiDay, May 2019
ITP 2.2 will have more of an effect on Google and Facebook than the previous ITP releases. This release will prevent Facebook’s pixel and Google’s tag from using unique identifiers to store information. These tracking mechanisms allow Facebook and Google to track a person’s visits long after they have clicked on an initial link, as the first-party cookie had not expired due to their strong first-party relationships (most people use Google and Facebook every 7 days).
As DigiDay states, Google and Facebook are the companies most affected by ITP 2.2.
1B. GOOGLE’S CHROME BROWSER
The privacy changes implemented to the Safari browser and Mozilla’s Firefox puts Google between a rock and a hard place on the privacy terms and conditions for the Chrome browser. Either Google proactively follows Apple and Mozilla, or Google risks Chrome’s reputation.
On April 9th, 2019, an insider leak in Adweek stated Google is “contemplating a number of changes to its consumer and advertiser-facing tools.” The translation is that Google may follow ITP 2.0 by disallowing thirdparty ad tracking software across browsing sessions. The market penalized Criteo with a 30% stock pullback, TradeDesk with a 15% pullback, and Alphabet’s stock was penalized with a 5% pullback.
“According to sources, certain Google teams want to placate the growing zeitgeist around the protection of consumers’ data privacy, which has grown ever louder since the Cambridge Analytica scandal last year. These internal discussions also follow the implementation of third-party tracking restrictions on Apple’s web browser, Safari, and similar moves from Mozilla’s Firefox and Brave’s offering in recent months. Although the various businesses within Google advocate similar measures, the breadth of the company’s interests (i.e., the dominance of its Chrome browser and ad-tech stack) make its decision-making process more complex.” -Adweek article Google Mulls Third-Party Ad-Targeting Restrictions:
And as part of that, we will have more changes through the course of this year, be it Chrome — Chrome is super committed to making sure it's best-in-class in privacy and security, and we always put user experience first and follow through. -Q1 2019 earnings call
Privacy restrictions have not been implemented for Chrome, however, we are watching this closely.
PRODUCT OVERVIEW CONCLUSION:
Google’s revenue is susceptible to stricter browser ad-tracking policies. Due to some iterations occurring in Q1, this may have affected the decrease in revenue that was reported. Regardless, Apple’s ITP 2.2 is specifically aimed at Google and Facebook.
We know that ITP 2.0 affected third-party ad companies by reducing CPMs by nearly 50%. If targeting is weakened through ITP 2.2, we will see a decline in click-through rates (CTRs) and CPMs as the people seeing the ads are not as likely to engage with the ad due to a lack of tracking/targeting. There is evidence that ITP 2.0 and ITP 2.1 may have already affected CPMs and CTRs (see below).
If this is the cause of the minor revenue miss, the situation should surface by Q3 – and most certainly by Q4.
Recommended Reading: Fallout from Apple’s ITP is Severe
SECTION 2: FUNDAMENTALS
2A. Q1 EARNINGS
Google is transitioning into a slower-growth company across most metrics. Earnings per share are expected to grow 4% to $45.46 although analysts are calling for a rebound of 18% EPS to $53.65 per share in 2020[1].
Google on April 29 reported earnings that topped expectations, excluding a $1.7 billion European Union fine. However, revenue fell short of estimates. Google’s advertising revenue rose 18% to $30.7 billion, missing estimates of $31.5 billion. This caused Google’s stock to sell off, falling below 1,236.54.
Analysts have a consensus of $11.49 EPS for the upcoming quarter (source: NASDAQ). Notably, Google beat on earnings but missed on revenue in the last quarter.
· Google’s 2019 revenue is expected to grow 17.3% to $160.5 billion from 23% sales growth in 2018.
· Revenue is projected to slow to 16.7% to $187.3 billion in 2020.
· Operating margin fell 21% in the December 2018 quarter, down from 26.5% in the first quarter of 2017.
· Capital spending rose to 18% of revenue in December 2018 quarter, up from 10% two years earlier.
Notably, EBIT, EBITDA and FCF were all stronger than expected, but the concerns around slowing growth in the Websites revenue segment is likely to affect stock price in the near-term.
"As expected, Google ad revenue growth has been slowing amid downward pressure on ad prices, especially for revenue coming from international markets," -Monica Peart, senior forecasting director at eMarketer.
“We appreciate quarterly results can be volatile and acknowledge the company’s long-term focus, but the magnitude of the deceleration on a constant-currency basis marked the largest sequential move down since 3Q12,” -Deutsche Bank’s Lloyd Walmsley.
“Overall, we expect GOOGL shares to be under pressure in the near-term given sub-20% revenue growth & downward earnings revisions. As noted above, the exact drivers of GOOGL’s slowing topline are unclear, & we believe frustration around GOOGL’s lack of transparency will only increase.” – JP Morgan
SECTION 2.2: Key Metrics
Aside from regulatory pressure, Google is already seeing some weakness in its core business with ad click volume rising but cost-per-click (CPC) growth trending downward. According to Marin Software and Merkle, CPC has slowed over the past five quarters.
Source: Marin Software
According to last quarter’s earnings, paid clicks on Google properties grew 39 percent, down from 66 percent in Q4 2018. The cost of the clicks also declined by 19 percent.
FUNDAMENTAL ANALYSIS CONCLUSION:
From an analyst’s perspective, it is very difficult to say a debt free company with $110 billion in cash that is growing at a rate of around 17% is at high risk over the next 2-3 earnings seasons. There are plenty of ways the product issues noted above could be alleviated. Placing ads in Google Maps could make up for lost revenue from browser changes, with one estimate valuing ads in Google Maps at $9 billion by 2023.
However, we feel that the changes to Apple’s Safari browser and Mozilla’s Firefox will have an effect on both Google and Facebook. Combined with weak technicals, I am placing a Hold on these two stocks with the anticipation they may enter a Sell recommendation over the next two quarters.
PART TWO: TECHNICAL ANALYSIS
Time Frame Comparison
Currently, Google’s price action is in a weakened state that warrants caution for longs. Some have likened Google’s current price movements to 2011, which a case could be made. I believe its price is eerily similar to late 2014, which is highlighted in the yellow circle in the chart.
That yellow circle shows where we are today vs. where we were in late 2014. What you’ll notice is that in both time frames, we completed a double top pattern on decreasing volume (where the yellow circle highlights the completion of that pattern). The initiation move down then took us below the 50 Day Moving Average.
Also, you’ll notice the similarity of the internals, as outlined in the RSI. Google, on higher volume, was in a strong uptrend in 2014, which can be seen in the elevated RSI levels in green. Then, as volume began to decrease, the RSI suddenly drops below 50 and starts to make lower highs, unable to break back above 60. In fact, at the double top peak in 2014, you’ll notice the RSI dropped below 50 and began the bearish internal pattern in red.
There is similarity between 2014 and today. We have the same double top confirmation with light volume, and very similar RSI changes from bullish in green to bearish in red.
Today, we have broken the 50 line on RSI, attempted to retest it, and broke below it again.
Further evidence of weakness in Google is found in the pink arrows. You’ll notice as the price of Google increased, the RSI was making lower highs, which is negative divergence – and usually indicates weakness in buying pressure and signals a drop in the near future.
And finally, the blue dotted line indicates long term support, which started at the beginning of this cycle uptrend in March of 2009. This is very strong support, which did not break in 2015 or 2016. Today, we are comfortably below this support, which, once again, is not a good sign for the near term.
Elliot Wave Analysis
According to Elliot Wave Theory, the 5 waves up/3 waves down framework is fractal. So, this is happening on multi-decade super cycles to minute moves in the market. In interpreting where we are, the 5-wave impulsive move up started in March 2009 and has completed its Wave 3 (July of 2018), and we are currently in the 4th Wave retrace.
Google, being a major part of the broad market, mimics the same movements. Thus, Google is currently in the middle of an A-B-C, Wave 4 retrace, which began in Late 2018 and appears to end in late 2019/early 2020. I believe we have completed the B wave and are now beginning the C wave down, which has the potential to take us sub $1,000, and in a worst case scenario, as low as the mid $700 region.
Based on my primary count using Elliot Wave as well as the internal structure of Google, I believe a retrace is likely. What would invalidate this count, which would force me to reassess a new count, would be if Google makes new highs – around $1300. An update will be provided if this occurs.
Scenarios:
• If you are long on Google, put a disciplined trailing stop on the stock and re-enter when the technicals and fundamentals agree on a more bullish outlook.
• If you want to trade conservatively, wait for Google to miss on revenue a second time between Q2-Q4 2019 and enter a short position or long-dated put. Especially watch for the effects of Apple’s ITP 2.2 as if/when effects are reported in Q2 or Q3, they will worsen over the course of the year.
• Higher risk scenario would be to purchase OOM puts that ends in March of 2020 prior to earnings.
• Any short positions should be closed if Google makes all new highs around the 1300 mark. Shorting stock is all about timing and discipline. We will update as we go along if support or resistance is broken.