Here’s the number that made analysts nervous on Google’s earnings call

Ruth Porat
Alphabet CFO Ruth Porat Getty Images/Chip Somodevilla

Analysts on the Alphabet earnings call kept trying to get the company to spill the beans about why it had to spend more money to make more money this quarter.

Google’s total traffic acquisition costs — the fees it pays to partner websites that run Google ads or services — were $3.8 billion, or 21% of total advertising revenue, which was up 13% year-over-year. That’s roughly in line with the company’s previous patterns.

But the portion of TAC that goes to distribution partners — the one-off deals that Google strikes to make sure that its search engine is the default option on things like the iPhone — popped 33% year-over-year.

That increase raised many analyst eyebrows.

Alphabet CFO Ruth Porat directly addressed the trend of increasing TAC at the beginning of the call — saying that Google’s strongest growth areas, mobile and programmatic advertising, both have higher acquisition costs — but Wall Street kept trying to tease out more details.

The concern here is that if Google has to pay more to its partners on mobile, and it’s seeing increasing growth in mobile, that TAC could eat away profits from its core business. Several analysts tried to get more specific information about Google’s search deals.

“How do average TAC rates differ on mobile versus desktop?” asked Macquaries Ben Schachter. “Are there any other notable contractual issues that differ meaningfully between mobile and desktop search partnerships?”

Another analyst was even more blunt:

“You talked about TAC rising because of the increasing mix shift towards mobile and programmatic — there seems like there was a little bit of an extra bump up this quarter,” said Mark Mahaney of RBC Capital. “Would there have been any one major renewal of a deal that would have caused that? It did seem to spike more than what you would get, I assume, if you just rolled out mobile and programmatic.”

Margin pressure

Some of the anxiety about Google’s search deals has become particularly frothy following a report earlier this year that Apple received $1 billion from Google in 2014 for using its search on iPhones, which was revealed in now-sealed court documents.

If Apple or other companies start pushing Google for higher search revenue splits on mobile, as mobile becomes a more significant part of Google’s business, it could hurt margins.

Porat declined to give any more specific information on TAC, saying only that mobile and programmatic have higher costs and expressing frustration at the analysts’ focus on the topic:

“And on your TAC question, as I’ve indicated a number of times already on the call, the TAC rate is higher on mobile.” (bolded for emphasis).

In fact, Google has hinted at the issue before, noting in its 2015 annual report:

Our traffic acquisition cost (TAC) may also be impacted because the rates at which we share mobile revenues with our partners may differ from our traditional desktop and tablet formats. We expect both of these trends to continue to put pressure on our overall margins, particularly if we fail to realise the opportunities presented during the transition to a dynamic multi-screen environment.

Porat stressed on Thursday’s call that Google is benefitting from mobile overall and will “continue to innovate” and is “excited about the opportunity.”

For what it’s worth, not all investors are worried: In a note on earnings this morning, analysts from Deutsche Bank called the anxiety over the distribution TAC increase a “largely overblown concern.”

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