Click (or touch) here to read the latest article covering Google's Q3 2011 results and updates to the Android population and profitability models.
Google Q2 2011 Financial Results
by Mark W. Hibben
Investors heaved a huge sigh of relief following Google's Q2 Financial Conference Call on July 14 and apparently decided that Google wasn't such a bad investment after all: the stock popped almost 13 % after hours and held onto most of the gain the following day. The news was good but not spectacularly so, indicating to me that Google had simply been very oversold. If we exclude the one-time charge of US$ 500 M Google set aside in Q1 to deal with ongoing Department of Justice investigations, Google's financial performance has been fairly normal in both Q1 and Q2, as the summary table shows. Revenues continue to trend up, showing a healthy y/y gain of 32% Also, there are signs of improved cost discipline, as we'll see as I pick apart Google's financials later in the article. And there was even exceptional news on the Android front, with reported activations now totaling 550K/day.
Android Population Model - Trashed
Although the news was generally good for Google and their investors, my Android population model took a real beating. The Android activation rate of 550 k/day, which Google execs reiterated twice just to make sure everyone got it, completely blew past the model, which showed activation rate leveling out in the 350k-400k /day range. Well, it was just an empirical curve fit to the pronouncements of activation rate that Google execs have been making at the quarterly conference calls for the past year, as well as some other data I had gleaned. But there was an underlying assumption that Android device demand was beginning to saturate, and thus activation rate was leveling off.
Even more perplexing was the announcement made by Susan Wojcicki that Google had activated a total of 135 M Android devices. While this reflected refreshing candor, possibly due to the new CEO, Larry Page, this was way lower than mine and most others' expectations. It doesn't help that this number appears to be somewhat at odds with the latest activation rate number of 550k/day. For instance, if that activation rate had been sustained all quarter, then about 50 M Android devices would have been activated in the second quarter alone. Since the Q2 2010 conference call, Google has announced activation rates every quarter. One can calculate a reasonable estimate for the quarterly Android device activations by simply multiplying the activation rate by the number of days in a quarter, 91.25, as summarized in the table below:
|Quarter||Reported Activation Rate per day||Quarterly Device Activations|
|Q1 2010||None, assumed to be zero||0.000E+00|
If we assume that the announced activation rates apply all during the quarter, then the total of activated Android devices should come to about 150 M, not including Android devices shipped prior to Q2 2010, as illustrated in the chart adjacent:
Apparently, integrating the announced activation rates doesn't provide a good estimate of Android population growth. This is because Google hasn't provided enough information about what they mean by "Activation Rate". Is this a mean value meant to apply for the entire period of the quarter, or something else? Google hasn't said. Hopefully Google will continue to be open about Android device activations going forward. Hard numbers on total Android device activation, updated quarterly, will be most welcome.
In the mean time, I've modified my Android population model with an "effective" activation rate profile. This profile, a straight line, isn't a particularly good fit to the announced activation rates, but it yields a total for Android activations of exactly 135 M, a number I'm assuming is correct. The total current Android device population is estimated to be somewhat less, at 128 M, to account for replacement of older Android devices. My comparison of Android and iOS population growth is shown in the chart below. The Q2 value for iOS device population 208 M is based on the total sales of iOS devices of 220 M reported by Apple in their 7/19/11 financial conference call.
As can be seen, Android still has a long way to go to achieve parity with Apple iOS. Although the Android population model has become even more "empirical", it still supports my Google financial analysis well, as will be seen in subsequent sections.
Revenue and Cost Model Updates
As explained in Android Profitability, Revisited, Google revenues depend on the number of devices that can host Google ads and sites. These devices include desktop and laptop personal computers (PCs independent of OS), and mobile devices. I currently only count iOS and Android mobile devices since other mobile devices such as Symbian phones offer very limited browsing capability, and the number of Windows 7 Phone devices appears to be negligible, but this could change. The average revenue Google obtains per device is currently estimated to be US$ 4.83 per quarter, and as previously noted, I apply this estimate to all devices regardless of type, even though there probably is some variation by type. The model estimated revenue is just this number multiplied by the total population of devices (PC, iOS, Android) for a given quarter.
Google’s Revenue Cost, which includes Traffic Acquisition Cost, is directly proportional to revenue, and therefore revenue costs for PC and mobile devices should also be proportional to the respective revenues. The Q1 decline in revenue cost appears to have been erased in the current quarter results, indicating that it was indeed a short term aberration rather than a long term trend. The general trend is that revenue and revenue cost rise proportionately to the increase in the worldwide population of mobile and personal computers.
This is good for Google and Google’s investors, since it provides guaranteed revenue growth.
One wouldn’t necessarily expect Google’s other major cost categories to also grow proportionately with device population. After all, there’s no direct linkage between G&A, Sales and Marketing, and Research and Development to device population, and Google management are more or less free to spend as they see fit. However, if Google management are “living within their means”, then the long term trend in these spending categories should correlate with revenue, and therefore with device population growth as well. Thus, in the following charts, I also provide breakdowns of cost by device population, PC, Android, iOS, but it should be understood that these represent device proportional contributions to the budget category, such as Sales and Marketing, and not necessarily how the cost item budget is allocated.
For instance, there's a Research and Development cost allocation for iOS devices, but there's really no way to tell how much of Google's R&D budget is actually devoted to iOS devices.
Most of the cost items track the Estimated cost fairly well. Last quarter there was a significant divergence in the Sales and Marketing and Research and Development categories, indicating significant "investment" for the future in these categories.
Thankfully, Google management are starting to rein in the cost growth in the R & D category, but Sales and Marketing still appears to be diverging from the model predictions, indicating a possible lack of discipline in this critical business cost component.
I continue to suspect that much of the cost in excess of the model in both the S&M and R&D categories is due to Android, and I have speculated before that Google may be capturing both technical and marketing support to Google's Android partners as "marketing" cost.
Was Android Profitable?
As in the past, Android, treated as a standalone business, showed a profit according to my population based model of revenue and cost shown adjacent:
For the current quarter, I estimate Android related revenue to be US$ 620 M with total Android related costs to be US$ 408 M for a net Android income from ops of US$ 212 M, slightly better than last quarter's estimate of US$ 188 M. As the Android device population grows, so grows Google's Android based income. How much of the excess total S&M cost and R&D cost (above the model predictions) is attributable to Android remains a question. The excess S&M cost was US$ 168 M while the excess R&D cost was US$ 56 M for a total of US$ 224 M. If we assume that Android accounted for half of that excess, US$ 112 M, then Android still had net positive income of US$ 100 M. Not bad for a fledgling Mobile OS supported by advertising revenue.
Here, I've also treated iOS as a standalone business, with its own estimated revenue, expenses, and net income from ops. Whether Google is really allocating expenditures for iOS related activities in the way I've assumed is open to question. iOS income in this case is really an estimate for "Other Mobile" income, not including Android. And it's always possible that Google is diverting Sales and Marketing and Research and Development expenditures that the model assumes were devoted to iOS, based on population, to other areas such as Android OS. The extent to which iOS may thereby "subsidize" Android remains a significant unknown in the model.
One of the major themes of the conference call seemed to be that mobile devices were a significant source of revenue growth for Google. Unlike the other major combatants in the War for Mobile Internet Supremacy (WMIS), Google is uniquely positioned to benefit from that growth, regardless of which platform becomes dominant.