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US Tech: The Thrill Isn't Gone

Can Internet platform companies such as Amazon, Facebook and Google live up to their hype? The short answer is yes.

After six disappointing quarters in a row for Google and persistent doubts about when and if Amazon will generate steady profits, many investors have recently started to wonder how long double-digit revenue growth can continue, and whether growth on the bottom line will ever be as impressive as that on the top line, according to Uwe Neumann, a senior technology analyst in Credit Suisse's Private Banking & Wealth Management Division. In other words, can Internet platform companies such as Amazon, Facebook and Google live up to the unceasing hype? Short answer: yes. Long answer: see below.

The Best is Yet to Come

Amazon, Facebook, and Google all announced better-than-expected earnings in the second quarter, which quieted some of those fears for the time being. But Neumann believes the investment case for platform companies goes far beyond a single good quarter. Indeed, he thinks the best is yet to come, that their biggest growth spurts are in the future, and not the past.

One of the arguments behind that thesis is familiar. Mobile is fast becoming the primary portal to the Internet, and the smartphone revolution is just beginning in emerging markets. As more people become glued to their phones, engagement on sites such as Facebook and Google should increase, along with the rates they can charge advertisers.

Grabbing From the Advertising Pie

Just as important, Neumann says, is the fact that the platform companies still have room to grab market share in industries such as advertising and retail. Online advertising comprises just 27 percent of the $550 billion global advertising pie, but by investing heavily in video, companies such as Google and Facebook are putting themselves in a position to compete with television for corporate ad dollars.

Between January and April of this year, the number of videos Facebook users watch each day increased from 3 billion to 4 billion. Sixty-five percent of monthly Facebook users visit the site every day. With that kind of engagement and growth, not to mention the ability to target ultra-specific demographics at a relatively low cost, corporations are going to shift an increasing share of their budgets to the 15-second video ads that automatically play on mute as users scroll through their Facebook feeds, Neumann says. Small businesses that could never afford television ads are also prime candidates for investing in paid video ads on Facebook.

More Time Spent on YouTube Videos

Google, too, has a bright future in video. In April, the company said that 30 major brands that had never advertised on YouTube had recently signed on to Google Preferred, which ensures that ads run alongside the most popular videos in a chosen category – and those brands have all chosen to stay with the service. Sales of TrueView ads, which either run before videos start or appear as display ads next to them, also increased 45 percent over the past year. The total amount of time spent watching videos on YouTube per session has also increased 60 percent over the past year.

The companies are sweetening the pot for advertisers in other ways. Google recently allowed brands to put shoppable tags into TrueView ads so viewers can click to buy featured products. The company has also started testing paid search ads that allow customers searching for a particular item to make a one-click purchase right from the results page. Facebook-owned Instagram announced in June that it would allow brands to add "Shop Now" buttons to their ads.

Travel Agents Feel the Digital Threat

Advertising isn't the only industry vulnerable to a digital land grab. Online travel reservations account for only 45 percent of the total market, and Neumann believes that, in particular, is well positioned to take further market share from traditional travel agents. And although Amazon is already an e-tailing Leviathan, online shopping still only accounts for just 5 percent of retail sales worldwide. That number can only increase.

Neumann notes that even if platform companies do have relatively low sales per user, still-fledgling services such as Amazon Prime, which charges $99 a year for faster shipping and streaming music and video services, are harbingers of change on that front. Apple Music, the company's new subscription-based service, is another example.

Finally, after years of heavy investment, some Internet companies might finally get around to cost-cutting. Neumann expects that after 3 years of heavy infrastructure investments, Amazon might turn to a better sales-to-cost relation. When Google's new chief financial officer recently discussed keeping a tighter rein on spending, markets reacted positively. With expanding market share, new sources of revenue, and a focus on cutting spending, an affirmative answer to the most persistent question about Internet companies – whether profits can ever impress as much as revenues – looks ever more plausible.

This article was originally published on The Financialist