Why the world's biggest search engine has to pay for traffic to its site

JP Mangalindan
·Chief Tech Correspondent
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Google pays fees to outside partners, otherwise known as traffic acquisition cost, or “TAC.”
Google pays fees to outside partners, otherwise known as traffic acquisition cost, or “TAC.”

Despite reporting solid financials on Monday, Google parent company Alphabet (GOOG, GOOGL) saw its shares dip almost 3% in after-hours trading that day.

One of the reasons investors punished the stock? The company’s higher-than-expected traffic acquisition costs, known simply as TAC, which refers to the payments tech companies make to third-parties that direct internet users to specific websites or advertisements.

In Google’s case, the search giant gives a cut of its revenues to outside ad partners in exchange for placement of Google’s ads on their websites and for making Google the default search engine on mobile devices from Apple (AAPL) and Samsung.

Google relies on TAC as a way to help maximize its revenue potential — an important distinction given Google continues to generate the lion’s share of its revenues from ads people click on. The more ubiquitous those Google ads are online, the more likely internet users are to view those ads, click them, and ultimately help Google earn a buck. It’s a kosher tactic that internet search companies such as Google, Yahoo, and Baidu.com have employed for years.

During its second quarter, Alphabet reported TAC of $5.09 billion — up from $3.98 billion the same time last year — which amounts to 22% of all of Google’s revenues. That’s a huge amount for Google to fork over, no matter how you slice it, and one of the risk factors investors paid keen attention to during earnings this week.

Unfortunately, Alphabet does not release much guidance around TAC. While Alphabet CFO Ruth Porat explained during Monday’s earnings call the challenges around the shift to mobile search traffic as one reason for driving TAC, and that she expected TAC “to increase,” the company did not specify exactly what those increases would look like. (Alphabet, as a rule, does not give forward-looking guidance for TAC.)

Without those crucial bits of data, that leaves analysts like Jason Helfstein from Oppenheimer & Co to potentially create their own estimates and models, which at the end of the day, are “best guesses” as to what TAC for any given quarter or fiscal year may be, he says. As he points out, Wall Street as a whole incorrectly guessed Google’s TAC increase for the second quarter.

“This has become a widely owned company,” Helfstein explained. “When the company is not necessarily beating the headline number, it gets punished.”

For Helfstein, the question is long-term. Google has long been the most trafficked website in the world. Given its global footprint and brand visibility, how much TAC does the company need to pay to maintain its position?

“They haven’t really chosen to play hardball here,” Helfstein explained. “At some point, they could say, ‘we’re really not going to pay you period.’ Because as far as search engines go, at least, Google is probably the go-to for many people, including myself. If Google search isn’t on by default, we’ll probably switch to make it that way.”

Still, while Google’s earnings obviously displeased investors in the short-term, analysts like Stephen Ju for Credit Suisse, remain unfazed.

“With this in mind however, the higher-than-expected revenue despite the lower flow thru does result in stable profit dollars for 2018, and overall our investment thesis for GOOGL shares does not change,” Ju wrote in a report released Monday.

Ju maintains his “Outperform” rating for the stock in the long term, based on factors including increased revenues from search products, businesses such as YouTube, Google Play and Google Cloud, and new, potential revenue opportunities that might arise around Maps and Waymo, the self-driving car business Google spun out late last year.

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JP Mangalindan is a senior correspondent for Yahoo Finance covering the intersection of tech and business. Email story tips and musings to jpm@oath.com. Follow him on Twitter or Facebook.

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