If an investor follows only market price action this week, it appears that Facebook (FB) had strong earnings, while Alphabet (GOOG) faltered. Nevertheless, the opposite is true. Primarily, it was this strength in retail ads that propelled Alphabet to post a healthy 23% growth. Meanwhile, Facebook (Meta Platforms) reported revenue growth of 9.7% and is guiding for nearly 0% growth from $28.5 billion in Q2 2022, the midpoint of Q2 2022. This analysis looks at why Alphabet has been able to weather the weather despite 80% of revenue coming from ads over the past two quarters, while Facebook is guiding for flat growth.
YouTube missed out on Alphabet’s recent earnings report, while Google Search beat. (Photo Illustration by … [+] Chesnot/Getty Images). Here’s why Alphabet stock is the better FAANG.
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Background:
The ad-tech industry remains in a whirlwind of changes following iOS privacy changes that limit third-party tracking on Apple mobile devices. We covered this in more detail here where we discuss the permanent changes to Facebook’s business model and also here where we discuss why ad stocks face a new, bigger challenge from Apple’s iOS changes.
I am highly focused on identifying who will follow these changes as winners and losers, as it will determine who will lead the ad-tech going forward. The issue is important as it affects major FAANG ad-tech companies such as Facebook (Meta) and Google (Alphabet). Wall Street especially likes ad-tech’s bottom line, and will suitably reward stocks that can capture more ad spend.
In the analysis given below, I review Focus on Google’s Q1 2022 results and its advertising platform (I’m ignoring Google Cloud for now) and look for signs to see if Google is being affected by recent iOS changes. You’ll find that Google has performed well relative to other app-based advertising platforms, such as Facebook, following the change to third-party identifiers. This is because Google has a first-party data advantage over third-party data, which is important when attribution and measurement by third parties is limited. I explain why in more detail below.
Google’s Q1 ad growth remains in-line
While the market is still digesting the previously mentioned macro headwinds – supply chain and Ukraine-Russia; The third headwind of attribution and measurement changes is the headwind that investors should pay most attention to as it leads to a material change in the story for ad-tech companies. In the meantime, the other two headwinds will resolve in time.
Q1 earnings provide valuable data on who are most and least affected. Two important data points are Facebook and Google’s Q1 results, as most of their sales come from mobile ads. Google recently reported that sales grew 23% YoY to $68 billion, in line with estimates. In addition, Google’s search business outperformed and grew 24% YoY to $40 billion. This follows the outperformance in Q4 as search sales grew 36% YoY in Q4, while overall Q4 sales grew 32% on a year-on-year basis. It may seem like Alphabet’s search revenue is slowing by 30% in the year-ago quarter, but the decline in search revenue is due to tough comps, and relative to Facebook, is outperforming.
The power of discovery highlights the advantage that first-party data provides. This is because the search is primarily performed on a browser, allowing Google to obtain valuable first party data from Google Chrome, Google Search and proprietary Android OS. In addition, Google is releasing new products, such as the Topics API, that enable behavioral targeting. This is a straight shot at meta platforms, which are known to be quite competitive on behavioral targeting via taxonomy.
However, while search remained strong, both YouTube and Google Network’s sales performance underperformed during the quarter compared to total ad sales. For example, YouTube grew sales by just 14% YoY to $7 billion, a sharp slowdown from the 25% and 49% YoY growth rates from the previous quarter in Q4 and Q1 2021 respectively. Google Network sales, which includes the Google Play Store, grew 20% YoY to $8 billion. It also represents a slowdown from the 26% YoY growth rate in the previous quarter. As I’ll discuss in more detail below, slowdowns in YouTube and the Play Store are likely unrelated to recent iOS changes and are more of a one-time nature.
Overall, total ad sales grew 22% YoY to $55 billion, down from the 33% YoY growth rate in the prior quarter. It’s notable that Google’s sales far outpaced Facebook’s revenue growth in the first quarter, despite the odds in the YouTube and Google networks. As shown below, Google’s ad sales grew nearly 3 times faster than Facebook’s 7% growth.
As shown above, Google’s ad sales grew nearly 3 times faster than Facebook’s 7% growth.
I/O Fund
I believe this improved performance was driven by Google’s first-party data advantage. For example, the slowdown in Google Networks was driven by a recent developer fee change, which reduced Google’s take rate from 30% to 15%. I take it as a sign of strength that Google Networks sales were able to grow 20% despite this outright growth headwind hitting comps. This is because the Google network is largely app-based (this includes Play Store, YouTube Music subscriptions, etc.) and apps have been more affected by the iOS changes.
In addition, YouTube revenue was the biggest laggard during the quarter and YouTube sales grew 14% YoY to $7 billion during the past three months (fun fact: YouTube is bigger than Google Cloud). The slowdown in YouTube may suggest that ads have been affected by iOS changes, but it’s important to consider that YouTube grew sales by 49% in the year-ago quarter, leading to a tough comparable base period.
During the Q1 call, Google’s management team explained that even “modest” growth from tough comp and direct response advertising has affected the segment, but noted that brand advertising remains an area of strength. Diversification in content types and the ability to present on a true all-channel strategy on mobile, browser and CTV contributed and suggested that brands have shifted advertising budgets to YouTube, possibly at the expense of competing platforms to measure ROI. because of capacity.
Google also reiterated this point during its Q1 conference call when CBO Philip Schindler explained that being able to fully measure what users do after clicking an ad is key to measuring ROI. He added that “measurement is also clearly a key component of success. [in CTV]And we want to ensure that advertisers can fully measure their YouTube CTV video investment on YouTube and YouTube TV to get an accurate view of actual incremental reach and frequency etc”.
CBO Schindler’s comments highlight the importance of measurement, a key aspect of digital advertising that has been challenged following changes to iOS cookies. If advertisers cannot measure ROI, they limit their advertising spend, so it is important that advertising platforms find solutions to measure ROI to sustain growth.
Perhaps the most important comment during the Q1 conference call was a statement by management that Google continues to see strength in retail, reiterating comments made during the Q4 2021 earnings call that retail (e-commerce) remains strong.
This brief description is very important, as it adds support that Google will not be affected as much by the iOS changes. Considering the signal loss from iOS changes, e-commerce has been one of the hardest hit verticals. Google’s strength here is likely due to its first-party data advantage.
Here’s what Facebook CFO David Weiner said about Google’s strength in the retail vertical during Facebook’s Q4 2021 conference call:
“E-commerce was one area where we saw a meaningful slowdown in growth in the fourth quarter. … But on e-commerce, it’s pretty noticeable — worth mentioning that Google called out seeing strength in that same vertical. And given that we know e-commerce is one of the workspaces most affected by iOS restrictionsIt makes sense that those restrictions are probably part of the explanation for the difference between what they were seeing and what we were seeing.”
Google’s statement that it continues to see strength in retail suggests it isn’t as affected by iOS changes relative to app-based peers like Facebook. Importantly, search is often based on a web browser (Google Chrome), which allows Google to limit signal loss by capturing first party data and deleting cookies on mobile based apps.
Our thesis at I/O Fund is that in this new cookie-less world, first-party data owners will outperform going forward. We expect Google to remain strong given its ownership of first-party data on both its search platform and the YouTube platform. However, Facebook will continue to struggle here because of its reliance on third party data and the “real estate” or need to collect data from this device by not necessarily owning the device and/or operating system so that it is supported. We recently wrote about this for Forbes: Facebook Stock: A Permanent Change in the Business Model
Two weeks ago, I held a webinar discussing changes to Facebook’s business model and why I think there will be a meaningful erosion in ARPU. This is a thesis we first published four years ago in 2018 when we warned that this FAANG was facing a lot of adversity. In the webinar below, we discuss why we believe the Meta Platform (Facebook) will continue to underperform and who will be the winners from this change, including first-party data owners, supply side platforms, and contextual ad publishers and platforms. Huh.
conclusion:
Notably, Q2 is particularly tough because there are three heavy macro headwinds: supply chain issues, the Ukraine-Russia situation, and the transition that Apple has forced with changes to attribution and measurement on iOS. When you add to that the one-time event of COVID, which reduced ad spend in Q2 2020, and subsequently increased ad spend in Q2 2021 the following year, the barrier to revenue growth is at a historic high. We believe those ed-tech stocks that may show top line growth right now are providing important clues when macro headwinds become clear.
Disclosure: Beth Kindig and I/O Fund do not own shares in Alphabet or Facebook and have no plans to change their status within the next 72 hours. The above article expresses the opinion of the author, and the author did not receive compensation from any of the companies discussed.
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