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Advertising slowdown hits big tech

Alphabet's lowest sales growth in two years puts pressure on share prices, while caution elsewhere at Microsoft has also taken investors by surprise
October 26, 2022
  • Advertising revenue at Google disappoints
  • Cloud revenue growth at Microsoft slowing down

Alphabet (US:GOOGL) and Microsoft’s (US:MSFT)  quarterly performances have come in below expectations as revenue growth slowed and rising costs pushed profits down compared to this time last year. This dragged down the share prices at Amazon (US:AMZN) and Meta Platforms (US:META) prior to their own earnings announcements.

Google’s parent company Alphabet makes all its profit from its advertising business and is suffering from tightening economic conditions. Group revenue rose just 6 per cent to $69bn (£59.7bn). This was a big slowdown from the 41 per cent growth last year and lower than analyst expectations of 9 per cent growth. For the first time, YouTube advertising receded, falling 1.8 per cent to $7.1bn.

A drop in marketing spending is expected in times of economic contraction, but this is compounded by the fact Google has extremely tough comparators from last year. During the pandemic, the e-commerce boom pushed companies to invest more in digital advertising. “The sequential deceleration in of year-on-year growth in the third quarter versus the second quarter primarily reflects further pullbacks in advertiser spend,” said CFO Ruth Porat.

Google Cloud continued its growth with a 38 per cent increase in revenue to $6.88bn. This was ahead of analyst expectations of $6.68bn, according to Factset. However, cloud operating losses did widen to $699mn from $644mn. Overall group profits fell 27 per cent from $18.9bn to $13.9bn. This has left Alphabet trading on a forward PE of just 18 times, compared a five-year average of 25 times. 

It was a slightly different story at Microsoft. Group revenue of $50.1bn beat analyst expectations of $49.7bn and was an 11 per cent increase on last year. Search and news advertising revenue also grew faster than Google with a 16 per cent jump.

Unlike Google, Microsoft’s cloud revenue disappointed analysts. It seems a bit churlish given Azure grew 35 per cent but analysts had expected 36.5 per cent growth. The more significant point came on an earnings call, when the company cautioned that Azure revenue growth was expected to fall five percentage points this quarter.

Overall cloud revenue, which includes services, was $25.7bn, making up 57 per cent of the business. At Google, the fast growing cloud business makes up 17 per cent of revenue. Microsoft currently trades on a more expensive forward PE of 23.7.

Metaworse?

Meta Platforms, formerly known as Facebook, saw its share price drop 5 per cent on the day of these results, ahead of its own earnings. The weak advertising results at Google suggest Facebook may also fall below analyst expectations. The consensus forecast was already for Facebook advertising revenue to fall 5 per cent on last year to $26.9bn. As it has less proprietary data on its users (like online shopping search history, for example), Facebook suffers more from changes to iPhone privacy rules than Google. Facebook's third-quarter results were released on Wednesday, post-publication; analysts forecast declines in sales and operating profits. 

Earlier this week Snap (SNAP:US), which also derives most of its revenue from advertising, saw revenue growth slow to 6 per cent. This was just below analyst expectations and the slowest pace of growth since the company’s IPO in 2017. Net losses widened to $360mn from $72mn, in part because of $155mn of restructuring costs in relation to mass lay-offs earlier this year.

Amazon, which reports its Q3 results on Thursday, also saw a sell-off in its shares. Investors are worried about the impact macro-economic conditions could have on both its retail and advertising businesses. Analysts are expecting group revenue to rise 15 per cent to $127bn with advertising revenue expected to rise 32 per cent. Given the apparent pullback in advertising spend this looks ambitious. For Amazon Web Services, the cloud business, sales are forecast to grow by 32 per cent to $21.2bn.

There used to be a belief the market dominance of these tech giants would lead to ever-increasing profits. However, once you reach a considerable size, exposure to macro conditions is inevitable. Those that offer essential IT services and cloud computing (Microsoft) will fare better than the more advertising centric (Facebook). Companies are going to lower marketing spend before they cut IT budgets.