ItInsightsWorld Review: Alphabet's Negative Cash Flow Highlights the Cost of AI Buildout and Slowing Search Ads
During the three months ended September 30, earnings released on Wednesday showed Alphabet's free cash flow at negative $9.1 billion, extending the second quarter's minus $5.9 billion and confirming that spending on artificial intelligence has become a major cash-flow burden.
Wall Street had expected a smaller cash burn; the result marks the second time free cash flow has turned negative since Google's public listing in 2004. In after-hours trading, Google's shares fell more than 10% after the company acknowledged that AI Mode, an artificial-intelligence conversational mode, is hurting traditional search.
Analysts say further share weakness could erase more than $400 billion from Alphabet's market value and set a record for the largest one-day market-cap loss in the company's history.
Cash-flow strain reflects a record AI capital-expenditure pivot
The negative cash balance is tied to record capital spending on artificial intelligence, a bet that the technology could reshape industry structure. Capital expenditure reached $51.3 billion in the third quarter, up from $44.9 billion in the second quarter.
Chief Financial Officer Anat Ashkenazi reiterated that capital expenditure this year will be as high as $205 billion, a path that implies fourth-quarter spending could reach $73.1 billion.
The company has committed more than $1 trillion to future data-centre purchases, leases, equipment, energy and other obligations.
To finance that plan, Alphabet has raised hundreds of billions of dollars in debt and announced in June a plan to raise about $85 billion through equity. This would be the company's first share sale in more than two decades and marks a decisive shift away from its long-standing buyback strategy.
Search advertising slows while group results miss consensus
Analysts flagged slowing search advertising as another concern. Alphabet's largest business, the search-ads segment, grew revenue 12% year over year to $63.4 billion, below the $64.9 billion expected by analysts; earlier this year, annual revenue growth for the segment had been close to 20%.
Chief Business Officer Philipp Schindler acknowledged that queries made in AI Mode are cannibalising traffic from traditional search and reducing ad monetisation. AI Mode answers directly with conversational text rather than presenting a list of links.
Group revenue in the third quarter increased 25% year over year to $127.6 billion, but remained slightly below FactSet's average analyst estimate. Net profit fell 25% to $26.2 billion, well short of Wall Street's $37.3 billion expectation.
Profit was also affected by valuation changes in Alphabet's investment portfolio, which includes a stake in SpaceX. During the quarter, Elon Musk's rocket-maker's valuation dropped about 4%, producing an $8.7 billion net investment loss. Excluding that loss, operating profit rose 30% to $40.6 billion, still below Wall Street's $43.2 billion forecast.
Ashkenazi noted that free cash flow was worsened by a $5.2 billion cash payment to settle a European regulatory fine arising from a 2018 case. Separately, Google recently lost a lawsuit over anticompetitive conduct involving Android, and its appeal against the ruling did not succeed.
Microsoft's cash-flow beat sharpens the contrast with Alphabet
Microsoft received a more positive market response on Wednesday. Azure's strong growth pushed revenue and profit above expectations, and the stock rose 4%; even as capital expenditure increased to $45.2 billion, the company produced $18.6 billion of free cash flow.
| Company | Free cash flow | Capital expenditure | Share reaction |
|---|---|---|---|
| Alphabet | negative $9.1 billion | $51.3 billion in the third quarter | down more than 10% after hours |
| Microsoft | $18.6 billion | $45.2 billion | up 4% on Wednesday |
Dec Mullarkey, managing director at SLC Management, said: “The market is carefully weighing the relationship between capital expenditure and free cash flow. Microsoft has shown outstanding cash-flow management while maintaining growth. Google has fallen short of expectations, and cash flow is expected to continue dragging on performance until next year.”
David Wagner, head of stock investing at Aptus Capital Advisors, said: “The market is truly worried about the search business. With investors concerned that AI chatbots will erode Google's core business, they need to see search accelerate, not slow down.”
Cloud momentum and a full-stack AI push keep the thesis alive
Google Cloud partly offset the weakness. Customer demand for Google's own artificial-intelligence services, together with sales of computing capacity to competitors such as Anthropic, doubled third-quarter cloud revenue to $30.7 billion.
Google frames its “full-stack” AI strategy as a competitive advantage: designing custom chips, building data centres, training frontier models and distributing them through existing applications and services to billions of loyal users.
Chief Executive Sundar Pichai has faced criticism for moving slowly on AI deployment, which critics say has allowed Anthropic and OpenAI to get ahead in lucrative enterprise markets.
Pichai pointed to two new versions of the most advanced Gemini model — Argon and Carbon — saying they have narrowed gaps in programming, finance and cybersecurity and may help Alphabet recover market share.