Shares of Alphabet Inc. fell more than 9% in after-hours trading after the Google parent reported a stunning earnings miss and a substantial drop in free cash flow at the end of its third quarter.
The search engine and cloud computing giant reported third-quarter adjusted earnings of just $2.67 per share, some way behind Wall Street’s target of $3.02 per share in earnings. Revenue for the period also came up short. Though it rose 25% from a year earlier to $127.58 billion, analysts had been targeting even bigger sales of $128.22 billion, and were sorely disappointed to see that the company couldn’t top that number.
The company’s first top-and-bottom line miss in almost four years meant that it also suffered an overall drop in net income, which came to $26.17 billion, down from $34.98 billion in the same period one year ago.
Alphabet also reported negative free cash flow of $9.07 billion, which was far lower than the $2.7 billion number expected by analysts. Even more puzzling is that executives cannot just blame the shortfall on artificial intelligence infrastructure spending. That’s because Alphabet’s capital expenditures in the quarter totaled $51.36 billion, falling short of the $55.09 billion expected by analysts.
Going forward, Alphabet Chief Financial Officer Anat Ashkenazi said, the company is maintaining its full-year capital spending forecast of between $195 billion and $205 billion. She also reiterated the company’s plans for this figure to exceed $300 billion in fiscal 2027.
Some investors have become increasingly concerned over the runaway spending plans of so-called hyperscaler cloud providers such as Alphabet and are looking for signs that they will be able to generate a return on those multibillion-dollar investments, but that doesn’t seem likely to happen anytime soon.
Alphabet continued to borrow heavily during the quarter, with its long-term debt rising to $125.1 billion, up from just $21.6 billion a year ago. That’s an increase of around 479% year-over-year. Alphabet also missed on operating income during the quarter, with its total of $40.58 billion falling short of the $43.19 billion targeted by analysts.
The company did enjoy a $99.03 billion revenue windfall through its equity holdings in AI firms such as Anthropic PBC and Space Exploration Technologies Corp. But that category also weighed on its bottom line, with net losses relating to those investments coming to $8.66 billion in the quarter.
The headline earnings miss looks worse than Alphabet’s underlying business is performing because it was driven mainly by financial rather than operating losses, stressed Investing.com analyst Thomas Monteiro. “But operating profit also came up short and that matters more,” he said. “Until now, AI spending only hit Alphabet’s cash flow, but this quarter it started showing up in profits too, and the pressure will only grow from here as depreciation rises and the cost of capital is repriced upward.”
Most of the money Alphabet is spending on AI infrastructure directly benefits its cloud computing division, which houses most of the AI services it offers, and the impact can at least be seen in its growing revenue. During the quarter, Google Cloud revenue more than doubled to $30.7 billion, surpassing the $28.7 billion analyst target. Google Cloud Chief Executive Thomas Kurian, appearing in a conference call with analysts for the first time, said the company is seeing “extraordinary demand and strong growth from AI labs, capital markets, financial service institutions and enterprises.”
Monteiro said investors will be pleased to see the growth in Google Cloud, but warned that this is also helping many of its rivals in the AI industry, which are tapping into its cloud infrastructure resources to power AI assistants and agents that compete with Alphabet’s own offerings. “Right now, Alphabet earns more selling AI to its rivals than using it itself, and that gap should keep growing over the next few quarters unless its models change drastically,” he said.
This has become a source of growing tension within the cloud infrastructure market, said Forrester Research analyst Tracey Woo. Though demand appears strong, there are questions about how much of that demand reflects broader enterprise adoption versus the concentrated spending of a handful of AI firms, she explained.
At least consumer adoption of Google’s AI seems to be growing. Chief Executive Sundar Pichai (pictured) told analysts that the Gemini app reached more than 1 billion users globally for the first time during the quarter, making it the fastest-growing product in the company’s history. He added that the company is also seeing strong demand for new models such as Gemini Argon. It announced two other new models this week as well.
Valoir analyst Rebecca Wettemann told SiliconANGLE that the big question for Google Cloud is capacity. The company is seeing enormous demand for its cloud services, she said, more than it can cater to, but in order to fulfill that demand it has to keep on spending. “But can Alphabet build fast enough to meet that demand, and at what cost as its free cash flow drops?” she asked.
Alphabet continues to fuel much of its AI infrastructure buildout using the revenue derived from its traditional search engine business, but investors are likely disappointed to see the company came up short there, too. Search revenue rose 12% in the quarter, to $63.35 billion, trailing the Street’s $64.96 billion forecast. However, Pichai said the company’s investments in AI helped drive the highest search query growth rate in the last five years.
“The softer search performance is significant because it highlights the challenge of funding massive AI investments while maintaining the strength of established businesses,” Woo said. “As hyperscalers continue to expand infrastructure at an unprecedented pace, enterprises will benefit from greater choice, increased competition and more pressure on providers to demonstrate value. The next phase of the market will be defined less by who can build the most AI capacity and more by who can help customers generate sustainable business outcomes from it.”