By Kenrick Cai and Akash Sriram
Oct 28 (Reuters) - Google parent Alphabet reported disappointing results in the core business of search advertising and a massive acceleration in cash burn as it poured resources into building out AI.
In a sign of corporate customers embracing the technology, Google Cloud revenues more than doubled, but investors unnerved by the huge price tag and a growth slowdown in the market-dominating search engine sent shares down 10% after hours.
"In a market worried about AI cannibalizing
the franchise, investors need to see search accelerating, not decelerating," said Dave Wagner, portfolio manager at Aptus Capital Advisors.
"Cloud is carrying the story, but until search shows AI is additive, the stock's probably going to trade lower."
The Mountain View, California company reported negative free cash flow of $9.1 billion, versus analyst expectations that it would come close to breaking even, LSEG data showed.
Aggressive efforts to boost cloud capacity and fund AI development led Alphabet to burn $5.9 billion last quarter, the first time it went into the negative in 22 years as a public company.
Total revenue missed Wall Street targets: revenue growth for Google Cloud outpaced expectations but was not enough to offset a $1.4-billion miss in advertising.
Alphabet's second straight quarter of negative cash flow was a sharp turn for a company that was long one of the tech sector's most prolific cash generators.
Moreover, Alphabet still plans to significantly increase its 2027 capital expenditures from this year's spending forecasts of $195 billion to $205 billion, Chief Financial Officer Anat Ashkenazi told analysts on a conference call.
While executives did not put a number on 2027 outlays, investors were nervous about a big jump.
"A $300-billion (capex) number could potentially scare the market because free cash flow now is finally negative," said Jeremy Saltsburg, senior investment officer at Check Capital.
In contrast, rival Microsoft, which also reported results on Wednesday, saw shares rise more than 5%, fueled by positive free cash flow that outstripped analyst estimates.
Ashkenazi added that she expected near-term margin pressure from the use of third-party cloud capacity.
Net income available to common Alphabet shareholders fell 25% to $26.17 billion, and adjusted earnings per share of $2.67 missed Wall Street targets of $3.02.
The results reflect the huge costs of the AI buildout, with investors concerned both by potential overspending and the risk of falling behind rivals by not spending enough.
Total third-quarter revenue of $127.6 billion fell short of analysts' estimate of $128.2 billion, LSEG data showed. Revenue from ads came in at $82 billion, missing expectations of $83.4 billion.
Chief business officer Philipp Schindler attributed a larger-than-expected deceleration in search advertising growth to greater use of AI Mode, a chatbot interface for the search engine with which the company is still experimenting on ads.
Google would begin rolling out advertisements in AI Mode to international markets, Schindler told a conference call.
CLOUD INFLUENCE GROWS
Alphabet attempted to offset the disappointing advertising performance by playing up its cloud computing unit, most notably by debuting Thomas Kurian, CEO of Google Cloud, as a speaker on the earnings call.
Revenue at Google Cloud exceeded estimates and more than doubled to $30.71 billion in the third quarter ended September 30.
Kurian said sales of Google's tensor processing units (TPUs), which compete with Nvidia's GPU chips, had become a meaningful contributor to his business unit.
Alphabet started recognizing revenue from direct sales of what it called its "TPU Systems", spanning not only the chips but also associated hardware and software, last quarter.
But Ashkenazi cautioned that the buildout of TPU inventory would further place pressure on free cash flow.
Google Cloud's backlog had grown to $561 billion and Alphabet expected to recognize more than 55% of it as revenue in the next 24 months, she added.
The third-largest cloud services provider globally after Amazon Web Services and Microsoft's Azure, Google Cloud has expanded enterprise commitments, supported by multi-year cloud and AI infrastructure deals across cybersecurity, retail and financial services.
Alphabet, Microsoft, Amazon, and Meta are projected to collectively spend well over $700 billion in 2026 to expand AI data center footprint, chips and high-performance networking capacity.
In the face of supply bottlenecks for advanced silicon and data center power, Alphabet's investments in custom tensor processing units alongside third-party GPUs have helped expand its service delivery capabilities.
Earlier on Wednesday, Google sought to preempt the results and counter a perception of losing out in the AI race by unveiling the new Gemini 4 Carbon model.
This meant the company was again "leading at the frontier," CEO Sundar Pichai said on the call.
Afterwards, analysts at Bernstein asked in a note, "Did Google rush the deployment of Gemini 4 models as an offset to softer financial metrics? And are the models ready for commercial deployment?"
(Reporting by Akash Sriram in Bengaluru and Kenrick Cai in San Francisco; Editing by Deepa Babington, Peter Henderson and Clarence Fernandez)
