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Search revenue growth slows from 17% to 12%; YouTube ad growth also softens
Capital expenditures hit $51.4 billion, driving free cash flow into negative territory for the second consecutive quarter
Alphabet shares tumbled in after-hours trading despite a dramatic acceleration in its cloud business, as investors weighed decelerating growth in its core advertising segment against soaring capital expenditures for artificial intelligence infrastructure. While surging AI demand successfully translated into top-line growth, the results laid bare the heavy financial burden of massive ongoing investments.
Reporting its third-quarter earnings on Thursday (local time), Alphabet stated that revenue rose 25% year-over-year to $127.577 billion. The figure fell short of the $128.2 billion consensus estimate compiled by LSEG, as cited by Reuters. Following the release, Alphabet’s Class A (GOOGL) and Class C (GOOG) shares plunged roughly 10% in extended trading.
In the advertising segment, both search and YouTube experienced softer revenue growth rates. Search and other advertising revenue climbed 12% from a year earlier to $63.35 billion, decelerating from a 17% growth rate in the second quarter. YouTube ad revenue rose 9% to $11.007 billion, falling short of the 13% growth recorded in the prior quarter.
The company attributed the slowdown in search revenue growth primarily to foreign exchange headwinds. It added that ad spending driven by the World Cup has normalized, while the European Union’s elimination of the VAT exemption for low-value imports also impacted retail advertisers in select Asia-Pacific regions.
Monetizing surging user engagement remains a key challenge for AI-driven search. Chief Executive Officer Sundar Pichai noted that total search query growth year-over-year reached its highest level in five years. However, Chief Business Officer Philipp Schindler explained that the relatively low monetization level of AI modes weighed on search revenue growth. The company is expanding the rollout of AI Overviews and AI ads while prioritizing user experience.
In the enterprise cloud unit, AI investments began bearing fruit. Google Cloud revenue surged 103% year-over-year to $30.709 billion, while operating profit more than tripled to $11.121 billion. Growth was propelled by enterprise demand for AI infrastructure and solutions, alongside sales of the company’s proprietary Tensor Processing Unit (TPU) systems.
Consolidated operating profit also climbed 30% to $40.576 billion. Conversely, net income attributable to common shareholders fell approximately 25% to $26.17 billion. Pre-tax investment losses on equity securities totaled $8.664 billion, reducing net income by roughly $6.7 billion. Chief Financial Officer Anat Ashkenazi cited mark-to-market losses on SpaceX shares as the primary driver of the deterioration in non-operating income.
Cash flow was constrained by heavy capital expenditures. While operating cash flow for the third quarter stood at $42.29 billion, capital expenditures reached $51.355 billion. The resulting free cash flow—the difference between the two figures—came in at a negative $9.065 billion, marking a second consecutive quarter of deficit.
Beyond equipment spending, inventory accumulation and regulatory fines also weighed on cash flows. According to the company, inventories rose as it prepared for TPU system sales. Furthermore, the finalization of appeals regarding a fine imposed by the European Commission (EC) in 2018 resulted in a $5.2 billion cash payout.
Alphabet maintained its full-year capital expenditure guidance at $195 billion to $205 billion, while anticipating a substantial step-up in investment next year. To meet surging compute demand, the company began utilizing external computing capacity late in the third quarter and plans to scale up its usage in the fourth quarter. Consequently, management warned that cloud margins could face near-term pressure. Depreciation expenses tied to surging infrastructure investments and rising data center operating costs, such as power, were also cited as earnings headwinds.
Financial news provider Investing.com reported on Friday that Barclays lowered its price target on Alphabet from $425 to $405 while maintaining an 'Overweight' rating. Barclays analyst Ross Sandler praised the cloud division's robust growth, but noted uncertainties surrounding the path from rising AI search engagement to ad monetization. While the stock retains its investment appeal, shares are likely to remain under pressure in the near term, the report indicated.
