Google's Weakening Ad Revenue Growth Hides Rising Stars

Google's Weakening Ad Revenue Growth Hides Rising Stars
Google Inc's decelerating advertising business is masking the stellar growth of significant but little-noticed business components such as sales of digital music, software and mobile devices.

On Thursday,Google  reported weakening growth in ad volumes in the third quarter, fanning worries on Wall Street about the Internet company's efforts to adapt its business to a mobile landscape.

But one bright spot that analysts and investors say may become a bigger growth engine in future quarters is sales of digital music and apps, as well as hardware.

Google's Play store, which sells apps, movies, music and games, is among several businesses not based on Google's long standing advertising activities that are part of its prosaically named but fast-growing "other" segment.

That segment accounted for 11 percent of Google's revenue in the third quarter and grew 50 percent to $1.84 billion.

"If I were to look at four metrics that are of critical importance, this would be one of them," BGC Partners analyst Colin Gillis said of that revenue segment. "It's another great monetization of their mobile platform."

While the shift from PCs to smartphones has pressured prices for Google's ads, it has also spurred an attractive business opportunity for the company.

Revenue from the various businesses lumped in the "other" category could easily double over the next few years, said Needham & Co analyst Kerry Rice.

To be sure, the category is still something of a black box. Google does not disclose whether the segment is profitable and provided limited color about its super-charged growth on Thursday, citing only growth from the Play store and unspecified licensing revenue.

(Also see: Facebook Challenging Google in Online Advertising Market)

The category also includes nascent hardware efforts such as the Chromecast TV dongle that lets users beam videos from PCs to TV screens. Consumers have transferred videos that way more than 400 million times since the $35 gadget went on sale in July 2013, Google noted on Thursday.

Its hardware efforts likely carry much lower profit margins than the online ads that provide the bulk of its revenue. But sales of digital content could be very profitable.

While Google typically keeps roughly 30 percent of the revenue from sales of digital content on its online store, that revenue is much more profitable since Google has not incurred content creation costs, say analysts.

What's more, those sales help Google's overall business, including advertising. The more digital content that is available for mobile devices based on Google's Android operating system, the more consumers will be attracted to those devices.

"It increases the stickiness of the consumer, and increases the repeat rate of the consumer so that they stay in the Google ecosystem," said B. Riley & Co analyst Sameet Sinha.

He likened it to another famous symbiotic relationship in the technology business. "What would iPod sales be if there was no iTunes?" Sinha said, referring to Apple Inc's iconic portable music player and its accompanying music service.

© Thomson Reuters 2014


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