Google and Microsoft both flexed their muscle in terms of margins with nearly no impact over the past few quarters due to the macro headwinds. The quarter was stable in terms of both revenue and margins. 

There’s a chance the market is sniffing out that Q2 could be a bottom for financials. We need more information (this is not a statement written in stone) but there is evidence that some companies may have bottomed – Netflix’s return to (minimal sub growth), Tesla’s H2 deliveries guide, and Microsoft is a double-digit growth guide for FY2023 while predicting FX headwinds will ease between January-June. 

I believe Google’s rally is due to the company’s category leading strength in ads, specifically Google Search, and the prospects of what it will look like when YouTube bounces back. Due to lack of guidance, we don’t have any hints on whether Google bottomed or not, but comparatively the company is stronger than expected.  

You can watch my Bloomberg appearance here where I discussed this point Tuesday evening.

Alphabet Q2 2022 Earnings:

The company reported revenue of 13%, or 16% in constant currency, for a total of $69.7 billion. The operating margin was flat year-over-year, which is a win. Operating expenses grew 24% yet the operating margin was in line with previous quarters at 28% for $19.58 billion in operating income. 

The net margin was a bit weaker than previous quarters in 2021 at $16 billion yet in line with last quarter. The company has free cash flow of $12.6 billion. The company has $125 billion in cash and marketable securities.

Search was stable given the current environment at 13.5% growth to $40 billion and this provided relief that not all ad spend has been paused. Search was strong last quarter at 24% growth to $40 billion, and was flat sequentially. 

We covered the strength of search in our analysis: Alphabet is our Second FAANG.

“The strength in Search highlights the advantage that having first-party data provides. This is because Search is primarily done on a browser, allowing Google to capture valuable first party data from ownership of Google Chrome, Google Search and also from Android OS. Moreover, Google is releasing new products, such as Topics API, which enables behavioral targeting. This is a direct shot at Meta Platforms, who is known to be quite competitive on behavioral targeting through taxonomies.”

The effects of Google’s large R&D department and advances in AI cannot be overstated when it comes to the resiliency of Search in the current environment. We are getting a very slight glimpse of what’s to come for Google in terms of its advertising dominance. 

On the call, an analyst asked what is the company’s north star, given their margins are very strong. Later, the CEO discussed that his focus is using their cash to drive more R&D in AI, which flows through to Google Search and YouTube, which then generates more cash to drive more R&D, etc.

“So, for example, we are obviously investing deeply in AI. We do everything from pure research to applied research to research, which is now things AI work, which is actually happening very close or within the areas like Search and YouTube, et cetera.

And so, you can imagine a scenario in which we are prioritizing and on the margin moving resources to making sure we are driving product improvements, which flow through a moment like that. That would be an example of sharpening focus for me.

And when I think about the opportunities out of AI, just coming out of I/O this year, looking at the progress we have made, how much we have made progress with multisearch, how multimodal things are getting and the fact that people are now actually doing voice searches a lot, visual searches a lot, all that is a good example of how we are driving value in our core products.”

The expectations were that YouTube would weigh on the report yet YouTube provided a bit of growth at 5% year-over-year. The company was adamant that YouTube growth is low because of the tough comps. The tough comps was touched on many times, such as this: “the modest year-on-year growth rate primarily reflects lapping the uniquely strong performance in the second quarter of 2021.” 

The other issue is that just like hiring is seeing a reversion to 2019 levels, so is ad spend. The levels of ad spend seen in 2020-2021 are not sustainable which is why we are reverting back to 2019 in many of these growth rates. Regardless, the overall tone was positive about YouTube especially as YouTube shorts alone now has 1.5 billion signed-in users per month and 30 billion daily views.

Retail was discussed on the call. Although the management team declined to be granular with analysts, they did feel their products are better positioned to serve retail, as evidenced by the current growth rates compared to competitors, due to Omnichannel. Retailers prefer to drive both offline and online sales through multiple channels for in-store, online, curbside pickup which Google helps with across Search both mobile and browser, YouTube, and location-based searches/maps. Google introduced a new way to buy ads across all of Google’s channels called Performance Max with a single campaign to help more retailers tap into omnichannel.

We discussed in our recent Q3 webinar the importance of Big Tech capex, especially for semiconductor investors. This will be something to closely monitor in Q1 reports of next year in terms of expected capex. 

So far, so good for this quarter. We got the following from Ruth Porat, CFO: 

“Turning to CapEx. The largest investments in the second quarter were in servers followed by data centers and office facilities. After several large transactions closed in the first quarter, investment in office facilities was once again focused on fit-outs and ground-up construction on existing projects. We continue to expect an increase in CapEx in 2022 versus last year. For the balance of 2022, the increase will be particularly reflected in investments in technical infrastructure globally with servers as the largest component.”

Google Cloud slowed to 35.6% growth down from 43.8% growth last quarter. This means Google Cloud is growing slower than Azure on a lower revenue base. This is something to monitor in the future.

The company announced $70 billion in buybacks last quarter which is up from $50 billion in the previous year. This is also a marked increase from 2019 which saw $25 billion in buybacks.

Conclusion:

We had said this the following in our last write-up which pulls the pieces together to answer why Google has demonstrated stability in the face of ad-tech headwinds:

“Google also reiterated this point during their Q1 Conference Call when CBO Philipp Schindler explained that being able to fully measure what users do after they click on an ad is critical to measuring ROI. He added that “Measurement is also obviously a key component to success [in CTV], and we want to make sure that advertisers can fully measure their YouTube CTV video investments across YouTube and YouTube TV for an accurate view of true incremental reach and frequency and so on.”

CBO Schindler’s comments highlight the importance of measurement, a key aspect of digital advertising that has been challenged following the changes to iOS cookies. If advertisers cannot measure ROI, they tend to limit their ad expenditures, so it's critical that ad platforms find solutions to measure ROI in order to sustain growth.”

Ultimately, in addition to Google’s many channels, Google is resilient right now due to AI driving stronger ROI for advertisers. For example, AI-powered Performance Max has grown 5X year-to-date with case studies driving 60% more revenue. 

The company is also more defensible following Apple’s attribution and measurement changes as the Google can provide this on their OS and browser while offering an omnichannel strategy.