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Microsoft and Alphabet - Tech titans take a mis-step

Steve Clayton | 25 April 2016 | A A A
Microsoft and Alphabet - Tech titans take a mis-step

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Microsoft and Alphabet, the company that owns Google, both dropped sharply after they released their results on Thursday. It wasn't a tech-sector sell-off, the Nasdaq barely moved, but both companies revealed news that unsettled Wall Street.

Alphabet, which dropped 7% after releasing results had a pretty simple issue which bothered the market; Google earns most of its money from advertising and in the latest quarter, Google found that its revenues per click, earned when someone clicks on an advert, dropped by 9% year on year. That didn't stop Alphabet reporting sales up 17.3%, to $20.3bn and net profits 20% higher at $4.2bn. But investors tend to focus on what they think are the key metrics driving a company's overall performance, in the hope of seeing what the underlying trends are. For Google, cost per click has long been a Key Performance Indicator for Wall Street Analysts.

When cost per click goes down, the market worries that the value of what Google offers advertisers is becoming commoditised. If that KPI heading south wasn't bad enough, Alphabet CFO, Ruth Porat said that margins were under pressure, because consumers were increasingly using mobile devices, not PCs and the cost of reaching consumers through mobile channels was higher.

Apple, for instance takes a cut of revenues earned from consumers clicking on Google links via their iPhones, which is a cut that Google would keep for itself were the consumer using a PC. In total, those sort of middleman costs jumped by a third to $1.2bn for the quarter.

Google changed its name to Alphabet a few quarters ago, because it wanted to show that there was more behind the group than just Google Search. But all of the other activities, from Driverless Car research to the Ventures investment group, only contributed $166m to revenues, whilst losing $802m in the process.

Microsoft saw its shares drop over 5% after missing market forecasts for earnings in its 3rd quarter. There is a massive cash cow at the heart of Microsoft, in the form of its core Windows operating systems and Office productivity tools, which sell in huge volume, month in, month out.

But even though revenues of $22.1bn were earned in the quarter, up 5% on the previous year, after adjusting for FX, the company's guidance for Q4, at circa $22bn was around a billion dollars shy of market forecasts.

There were some stand-out weaknesses in the numbers; the phones division, which has hardly sparkled, ever, saw revenues halve year on year. And whilst pronouncing the death of the PC is over-stating matters enormously, a nine percent drop in the market, according to Gartner goes a long way to explaining why personal computing sales were lower.

Microsoft is attempting to reposition itself toward a cloud-centric future, and is spending at a record rate to deliver the infrastructure of data-centres and servers required, so the market was unimpressed that despite an outlay of $16.8bn in a single quarter on capital investment, cloud-based revenues rose just 3%.

So two tech giants, each with distinct strengths and weaknesses. Google continues to dominate Search, just as Microsoft Office is the unchallenged leader in standard business software. But declining pay per click and sluggish growth up in the cloud suggest both companies face hurdles ahead. Both still generate vast cash flows and have enormous cash reserves on their balance sheet.

So whilst there may be a few waves on the sea at the moment, perhaps investors should not be too concerned. After all, with Alphabet/Google sitting on $75bn of cash, and Microsoft having $61bn in the bank, both companies can buy themselves out of an awful lot of problems, before anything gets too serious.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.