By Deborah M. Todd and Narottam Medhora
(Reuters) - Google's parent Alphabet Inc (O:GOOGL) missed Wall Street targets for first-quarter profit and revenue on Thursday as it spent more money to build traffic for its mobile advertising services.
The results, which were also hit by the strong dollar, drove shares of the Web search company down 6 percent in late trading Thursday.
Alphabet's consolidated revenue rose to $20.26 billion from $17.26 billion, slightly below the $20.37 billion analyst consensus, according to Thomson Reuters I/B/E/S. Non-GAAP earnings per share of $7.50, excluding one-time items, missed analysts' expectations of $7.97.
Chief Financial Officer Ruth Porat said on a conference call with investors that payments to other web sites, known as traffic acquisition costs (TAC), totaled $3.8 billion and accounted for 21 percent of advertising revenues. The percentage of ad revenues spent on TAC grew 13 percent year-over-year.
That reflects the ongoing shift to mobile advertising and the growing importance of programmatic advertising, in which ads are bought, sold and displayed by automated systems.
Investors should get used to seeing increased TAC as "the cost of doing business," said Sameet Sinha, B. Riley & Co. analyst.
"If you're getting mobile searches from Apple (NASDAQ:AAPL) devices you have to pay Apple for traffic so that revenue can happen," Sinha said. "The same thing on the programmatic side, when you end up representing more people and selling their ad space or buying their ad space, you have to pay somebody else."
Porat said spending on traffic acquisition is expected to keep rising as the shift to mobile continues - pressuring the company's traditionally robust margins on its advertising business.
"I think investors expecting stable margins are probably being overly optimistic. But that said you can have diminishing margins and still have a great business and an incredibly lucrative one," said Pivotal Research Group analyst Brian Wieser.
Google's advertising revenue increased 16.2 percent to $18.02 billion, while the number of ads, or paid clicks, rose 29 percent, the company said.
OTHER BETS
Losses increased at the company's Other Bets business, which includes its broadband business Google Fiber, home automation products Nest, self-driving cars and X - the research division that works on "moon shot" ventures.
The loss widened to $802 million, up from $633 million a year earlier. Revenue rose to $166 million from $80 million.
Compared to Google's overall business, Wieser said losses in other bets were "too small to matter" at the moment.
"If you're an optimist you can look to [other bets] and say it can eventually support long term growth."
Porat said foreign exchange rates factored heavily into the results, shaving $762 million from its revenue for the quarter or $593 million after the effects of a currency hedging program.
"Our total revenue grew 23 percent year-over-year and declined 4 percent sequentially, reflecting holiday seasonality," she said on the conference call.
Martin Pyykkonen, an analyst at Rosenblatt Securities, said the effect of foreign currency was worse for Alphabet than expected.
"If there had been a little better foreign currency translation, it would have been better than the Street consensus," he said.
Alphabet's total net income rose to $4.21 billion, or $6.02 per Class A and B share and Class C capital stock, from $3.52 billion, or $5.10 per share.
The company's shares fell to $732.94 in after hours trade from a close of $780.