GOOGL Alphabet Inc

By Jack Nicas 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (July 25, 2017).

Google parent Alphabet Inc. said its advertising business continued to hum, but its fastest-growing segments -- mobile and YouTube advertising -- are less lucrative than desktop ads.

Alphabet said clicks on its ads surged 52% in the second quarter from a year earlier. But ads on smartphones and with YouTube videos generally earn less money per ad than search ads on traditional computers, the highly targeted ads that appear atop search results. As a result, Google said its revenue per click fell 23% in the quarter, the widest spread between the two metrics in at least six years.

The growth in the number of clicks helped boost second-quarter revenue 21% to $26.01 billion over a year prior.

"The results are reflecting two basic trends: an ongoing shift to mobile and an increasing amount of their revenue coming from YouTube," said Mark Mahaney, internet analyst at RBC Capital Markets. "The growth remains very impressive for a company this size."

That shift in its business has also pressured margins. Alphabet's operating margin was 26.4% in the quarter, compared with 27.8% a year ago, marking the first drop in eight quarters, said Brian Wieser, analyst at Pivotal Research Group.

The shift to smartphones is increasing the fees Google pays to smartphone partners, such as Apple Inc., to be the default search engine on smartphones. Google's payments to partners, including phone makers and websites on which it places ads, increased 28% to $5.09 billion in the quarter from a year earlier. YouTube's growth also drives up costs because Google must pay to license some videos on the site.

Such payments to partners will likely continue to increase given the shift to mobile, "but our focus remains on growing profit dollars," Alphabet Chief Financial Officer Ruth Porat said on a call with analysts. "We're just really pleased with the strength of our mobile business."

Alphabet's net profit fell by 28% to $3.52 billion because of a $2.74 billion fine from European regulators. EU regulators last month fined Google after their seven-year investigation concluded Google favors its shopping ads in its search results at the expense of competitors. Google denies the charges and said it is considering an appeal.

Alphabet shares, up 26% this year, fell 3% in after-hours trading.

Google, the world's biggest advertising company, dominates the digital-ad landscape with fellow tech giant Facebook Inc. The two firms captured about 77% of the $12 billion increase in spending on online ads in the U.S. last year, according to eMarketer. Given Google's size, if it continues to earn less per ad click, it could depress online-ad prices across the internet.

As more people connect to the web on smartphones, they are using the internet more often and thus clicking on more ads Google sells on internet search results, websites and videos. Ads also take up a larger portion of smartphone screens, making it more likely that users will click.

On YouTube, Google often shows ads at the beginning of videos that companies buy using an automated auction system. That system of programmatic advertising caused a problem for Google earlier this year when a series of news stories in late March showed Google was running some brands' ads alongside videos with content that could be considered racist or hateful. That caused some major advertisers to pull their spending on YouTube ads.

As of last month, many major companies, including Wal-Mart Stores Inc., AT&T Inc., and J.P. Morgan Chase & Co., still hadn't resumed spending on YouTube ads. Others, including General Motors Co., Coca-Cola Co. and Lyft Inc., had returned to the site after Google improved technology to screen videos, among other moves.

There was little sign of an impact from those spending cuts in the second quarter sales growth.

However, marketers have pressured Google to offer more guarantees that their ads only appear with acceptable content, likely squeezing margins, Mr. Wieser said. Google is likely showing more ads on reputable websites as a result, which charge more to host Google's ads than lesser-known sites, he said.

YouTube ads, specifically, are much cheaper for advertisers, said Mark Ballard, vice president of research at Merkle Inc., a digital-marketing firm. Merkle estimates that for just Google search ads, clicks increased about 23% in the quarter and revenue per click was up roughly 1%. "The shift to mobile is depressing [revenue-per-click] growth for Google, even in search, but by far the biggest factor of that decline is YouTube, " Mr. Ballard said.

Google is pursuing growth outside of advertising, giving rise to a second major business beyond advertising: the cloud, in which Google stores other companies' data and runs their systems on its global network of computers.

Google has said it believes the business can one day eclipse its ad sales, which accounted for 88% of its $90.27 billion in revenue last year.

The segment that includes Google's cloud sales, dubbed "other revenue," grew by 42% in the quarter to $3.09 billion.

Write to Jack Nicas at jack.nicas@wsj.com

(END) Dow Jones Newswires

July 25, 2017 02:47 ET (06:47 GMT)

Copyright (c) 2017 Dow Jones & Company, Inc.