Alphabet’s 4Q16 Earnings

A one-time tax benefit ruined Alphabet’s recent quarterly earnings release. Alphabet’s earnings for the fourth quarter of 2016 were lower than analysts estimates when compared with the prior year.

Contributing to the less than expected earnings was a higher tax expense of $1,524 billion as compared with $277 million from the prior year.  On the conference call, CFO Ruth Porat described the tax hike this way:

And then, the other item I noted was, with respect to our tax rate. I noted that there was a slightly elevated tax rate this quarter. It’s always affected by the geographic mix of results, but we did have a discrete item that affected the US tax rate, just to make that clear.

Some attributed the “discrete item” to a one time adjustment for stock based compensation. But this is not the case. In fact, the “discrete item” was from the prior year as stated in Alphabet’s SEC Filings:

Our effective tax rate for 2015 included a discrete tax benefit related to refunds and reductions in uncertain tax positions due to the resolution of a multi-year tax audit in the U.S.

At the end of 2015, Alphabet revised its estimated tax expense as a result of an IRS audit that covered many years. The IRS ruled in Alphabet’s favor causing the tax expense to be less than expected. The adjustment occurred in the 4th quarter of 2015 and made the 4th quarter of 2016 higher in comparison.

Income tax expense is not really the amount of taxes paid; instead it is an estimate. At the conclusion of its IRS audit, Alphabet’s revision pushed the effective tax rate to five percent for the quarter. One year later, the quarterly effective tax rate when back to “normal” at around twenty-two percent.

All of this should prove that GAAP based financial statement are somewhat meaningless or at least can’t be taken at face value. In their recent book, authors, Baruch Lev and Feng Gu, argued that GAAP based financial statement include so many estimates, that true corporate earnings are often obscured.


The Garage Sales of Silicon Valley

Alphabet joins this month’s garage sales in Silicon Valley. In late March 2016, Bloomberg broke the news that Boston Dynamics was up for sale. The sale comes after Google purchased the robotics company in 2013. Alphabet’s fire sale is matched by Yahoo’s perennial sale of its core business.

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It not faulty technology causing the “for sale” sign at the Googleplex. The reason is finance, New York City style. No one knows when Wall Street invaded Silicon Valley; but for Alphabet, it happened last year with the hiring of new CFO, Ruth Porat. Ms. Port came from Morgan Stanley to provide financial discipline to the newly created Alphabet.

Google became Alphabet to resemble Warren Buffet’s holding company, Berkshire Hathaway. As Berkshire’s head, Buffet’s main job is allocating capital among the many businesses owned by Berkshire. In the same way, Ruth Porat’s job is allocating Google search cash among Alphabet’s other bets.

So Boston Dynamics‘ sale shouldn’t be a surprise. Alphabet’s first 10-K announced the changes in January 2016: now Alphabet’s businesses would be managed according to “resource allocation” and “performance assessment”. Boston Dynamics did mostly research and was far, far away from selling a robot.

So with a dim commercial future, Alphabet must have decided to allocate its capital elsewhere and sell Boston Dynamics.