The mystery of Google's 'other revenue'

The Internet search giant doesn't quite know what it wants to be when it grows up, and that leaves investors and analysts struggling to place a value on the stock.

By MSN Money Partner Feb 28, 2014 11:49AM

Mitch Heinrich, part of the Google [X] team that worked on CNBC on MSN MoneyBy Maggie Overfelt, CNBC.com


Google (GOOG) doesn't know what it wants to be when it grows up, and that's making it hard for some shareholders and technology analysts to place a value on the search giant.


The struggle comes when considering Google's recent forays into sectors like alternative energy, self-driving cars, smart smoke detectors and robotics that might be developed to better supply chain management -- things that at the outset seem to go far beyond the online ads that make up the bread and butter of Google's revenue and the basis of its stock price.


"None of this stuff fits," said Rob Enderle, president of the Enderle Group, a technology consulting firm. "In terms of maturity, Google has touched the bottom of the pie, not the top -- and they're trying everything."


Google missed profit expectations for the fourth quarter of 2013, reporting $12.01 a share versus the $12.20 that analysts were calling for. Despite somewhat of an earnings slog -- over the past couple of years, Google has missed more than it has met analysts' expectations -- Google's stock price is up more than 50 percent over the past year, boosted by a host of solid metrics in its recent earnings report, which came out January 30.


The company's wild experiments are bolstered by its massive cash cow -- core revenue in its Internet business rose 22 percent, while clicks on search ads increased 31 percent -- which helped nudge overall revenue to $16.86 billion, up 17 percent over the year before.


Investors also rallied around Google's "other revenue," which grew 99 percent, doubling year-over-year to $1.6 billion and up 34 percent quarter-over-quarter.

While the "other" column likely had investors scouring the conference-call transcript for details of Google X investments and its recent $3.2 billion acquisition of Internet-connected thermostat and smoke detector maker Nest Labs, Google said the revenue stream came mostly from stellar sales in its Play store, where Android users go to buy apps, books and music.  


On the January 30 earnings call with analysts, the company remained vague about new directions. "As you know from the Nest acquisition and (Google) Glass and wearables, we continue to innovate and we continue to be committed to the hardware in areas that are kind of enterprising, promising; new frontiers where we're actually focusing," said Google CFO Patrick Pichette.

A Google spokesperson declined to elaborate.


Hey, big spender
No one doubts Google's dominance of online ads or its ability to adapt to mobile. According to research firm eMarketer, Google holds about 40 percent of mobile and desktop digital ad revenues in the U.S. and more than 30 percent worldwide, followed by Facebook's (FB) roughly 8 percent and 5.6 percent. Some of Google's ad market competitors are growing their share at a faster rate than Google, and that has led to questions about its "dangerously undiversified revenue base" in the words of Mohanbir Sawhney, a technology professor at Northwestern University's Kellogg School of Management.


Tech watchers are left wondering when they can expect some upside from the Internet giant's next big play, whether it be the integration of Nest or one of the half-dozen robotics upstarts it recently bought. "(It's) a good question, and it's one that most analysts grapple with," said Victor Anthony of Topeka Capital Markets, who has been covering Google since its initial public offering in 2004. Anthony retains a buy holding on Google. "Investors always worry when CEOs spend their capital -- they wonder about the long-term return on the use of that capital. These (new ventures) are long-term initiatives, and the returns aren't immediately clear," he said.


Analysts say that many of Google's far-reaching plans are at least 10 years out and won't likely impact its stock until it reaches "the point at which that business (segment) hits the billion-dollar revenue mark," according to Sawhney. "That's when it starts to become relevant."


Ironfire Capital hedge fund founder Eric Jackson, who holds no position in Google, said, "Even though everyone is sort of excited about driverless cars, it's hard to take that technology and put a price on it and build it into your model about what Google should be worth today."


Nest may be the best short-term bet among all of Google's new long-term and far-flung ventures. Topeka Capital's Anthony says sales of Nest units may have the biggest, tangible stock impact over the next few years.


The Google of things
Melissa Schilling, a professor of management and organizations at New York University's Stern School of Business, points out how Google's Nest endeavor is likely a way to extend the Internet of Things to where we live, using artificial intelligence to make our interaction with things in our homes easier and smarter. "It's not the utility they were after -- there are lots of home automation solutions -- it's the interface with your home," she said. "It's how you make your home interact with you in a way that's less cumbersome."


Ironfire's Jackson said that Nest also represents potential ad dollars. "It's very easy to imagine how Google's core ad business is going to be further supported by knowing just that much more about you and your personal life," he said. "Nest is layering on that much more information to better understand you and which ads to show you."


The technology that powers Google's driverless cars may also fall along these lines "as cars become information portals on wheels," said Kellogg's Sawhney. Google will probably license the technology to automakers, removing the immense risk of becoming a carmaker itself.


For the long term, it helps to view Google and its new ventures through another lens: a company searching for new on-ramps to the Internet. "The first thing to look at is how do you define the core competency," Sawhney said. "From that standpoint, online search is not as Google would define itself—it takes a much broader view of how it thinks about its business, organizing the world's information as useful and monetizing that process." He added, "Google wants to own all of these on-ramps."


Charles O'Reilly, a professor of management at Stanford's Graduate School of Business, called these distant Internet-related projects a form of organizational ambidexterity -- the ability of a company to manage its current business while simultaneously preparing for changing conditions, even if it means moving in a somewhat different direction. "When companies are doing well, that's when they should be experimenting," he said, citing Goodrich (GR), the former tire company now entrenched in aerospace, and Nokia (NOK), which started out as a paper mill. "This is not random, it's not unrelated diversification; you only want to do this if the mother ship has some capability that it can leverage to its advantage in the new business."


Google's move into wind and solar -- the company recently made its fifteenth investment in renewable energy, pouring $75 million into the Panhandle 2 wind farm in northern Texas -- makes a little less sense to B-school professors looking at future revenue diversification schemes. "That's probably a pet project, an idealistic ambition from someone who is aiming to solve one of the world's biggest problems," said NYU's Schilling. Google thinks it makes sense as one of the world's largest consumers of energy.


And Google's off-the-path ventures -- which could go beyond Enderle's worry of a "self-driving car rolling over a line of kids waiting for a school bus" -- is a strategy that equity analysts think about as a compelling options portfolio in a volatile industry where no one's exactly sure what's next.


"(Google is) probing a lot of random veins; they don't quite know the outcome or what the return will be," said Kellogg's Sawhney. "But when a company is as large and as innovative as Google is, it can afford to make mistakes and do experiments."


Given Google's massive toehold in its core moneymaking market, analysts say the company isn't yet betting the farm. "It's not like (Tesla Motors (TSLA) co-founder) Elon Musk building a big factory and hoping that he can sell enough cars to pay it off -- none of Google's moves are costly enough to threaten the cash cow," said NYU's Schilling, noting that by not just doubling down on search, Google is making sure it will be around no matter in what direction the world will shift.


"But if we start to see lots of big acquisitions in other areas, that would make me very sad and definitely erode what I see as its core value," said Schilling.


More from CNBC


4Comments
Feb 28, 2014 2:33PM
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If there was a thing to watch as far as the Google Enterprise is concerned, it's internal "decay".  All businesses start off in similar fashion, that Google started.  By which, I mean that they start, fail, do poorly, or take off like a rocket.  Google started in the search engine mode, extended into the mapping (Google Earth etc.), then took off, but (and there is always a "but" somewhere in the scenario), they have extended their operations so far as to be what I call" incognito".

We all have used Google search for something, find a place, a thing, a sale, or whatever.  In the beginning a search resulted in a very high percentage of "relevant" results.  Obviously, that is no longer the case, and there is no one at Google who cares.  The irrelevancy is no longer confined to general searches, it now extends to fairly exact searches.  For example, try one of your specific searches like I tried.  I don't mean try my " true lies in blue ray format", I mean one that you would feel that should result in specific results.  You are very likely to see superfluous items like in my example, blue shoes, homes on Blue Street, the Blues Brothers, and so on.  My point is, that where the results were originally exact and useful, have become ludicrous.   Try to contact google to complain, duh, they have NO complaint department.   That costs money, and Google May be good at making money, but they are at the bottom of the heap as to responsiveness.

Mar 12, 2014 2:11PM
avatar
Google's willingness to engage in "moon shot" ventures may not please the "we demand to see the immediate profit potential" crowd, but I say hooray for them.  Not since Bell Labs have we seen a company this willing to engage in research for its long run potential.
Feb 28, 2014 2:19PM
avatar
Google is poised for the long run.  It won't be that long before you'll see ads placed on supermarket shelves that will be tailored to the individual walking down the aisle.  Or changing billboards, depending on who is driving down the road.  Google is the ground floor of this technology.  
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