Abstract:
The search giant admitted that its "artificial intelligence model" is impacting the traditional search business; both revenue and profits were lower than market expectations. Google has significantly increased its artificial intelligence spending, with related capital expenditures exceeding $50 billion in the third quarter, resulting in record cash outflows. At the same time, weak performance in the core search advertising business caused investor concerns, and Google's stock price fell sharply.
The financial report released by Google parent company Alphabet on Wednesday showed that in the three months to the end of September, the company's free cash flow further turned negative, falling to negative US$9.1 billion, compared with negative US$5.9 billion in the second quarter.
Google's cash burn far exceeded Wall Street expectations. This is also the second quarter in which free cash flow has been negative since the company went public in 2004.
In after-hours trading, Google's stock price fell more than 10%. At the same time, the company admitted that its chatbot-like “AI Mode” was hurting its traditional search business.
If the stock price decline continues, Alphabet's market value will evaporate by more than $400 billion, which will set a record for the largest single-day market value loss in the company's history.
The reason why Google’s cash flow has turned negative is that the company has invested record capital expenditures in artificial intelligence, betting that this emerging technology has huge potential to change the industrial structure.
Capital spending increased to $51.3 billion in the third quarter, up from $44.9 billion in the second quarter. Chief Financial Officer Anat Ashkenazi reiterated that the company's capital expenditures will top out at $205 billion this year. This means that capital expenditures in the fourth quarter may be as high as $73.1 billion.
Google disclosed that the company has committed to spend more than $1 trillion in future data center purchases, leasing, equipment, energy and other obligations.
To support this massive round of spending, Alphabet has borrowed tens of billions of dollars in debt and announced in June plans to raise about $85 billion. It would be the first time the company has raised money through a stock offering in more than two decades, marking a major shift from its years-long strategy of continually buying back its own stock.
In contrast, Microsoft received a more positive reaction from the market on Wednesday. Driven by the strong growth of its Azure cloud business, Microsoft's revenue and profits exceeded expectations, and its stock price rose 4%. Although its capital expenditures increased to $45.2 billion, the company still generated free cash flow of $18.6 billion.
Dec Mullarkey, managing director of asset management company SLC Management, said: "The market is carefully weighing the relationship between capital expenditures and free cash flow. Microsoft has demonstrated outstanding cash flow management capabilities while maintaining growth. Google has failed to meet expectations, and cash flow is expected to continue to drag down the company's performance into next year."
Core search advertising business growth slows, raising concerns
Analysts also pointed to the weak performance of Google's core search advertising business as another cause for concern.
Revenue from Google's largest business unit rose 12% year-on-year to $63.4 billion, but fell short of analysts' expectations of $64.9 billion. The business previously posted annual revenue growth of nearly 20% earlier this year.
Google Chief Business Officer Philipp Schindler admitted that queries in the "artificial intelligence model" are cannibalizing the traffic of the traditional search business and leading to a decline in advertising monetization capabilities.
Unlike traditional searches that display a list of links, AI mode directly provides conversational text answers.
David Wagner, head of equity investment at Aptus Capital Advisors, said: "The market is really worried about the search business. With investors worried that artificial intelligence chatbots will erode Google's core business, they need to see the search business accelerate growth, not growth slowdown."
Alphabet's third-quarter group revenue increased 25% year-on-year to $127.6 billion, but was still slightly lower than the average analyst estimate compiled by FactSet.
The company's net profit fell 25% year-on-year to US$26.2 billion, far lower than analysts' expectations of US$37.3 billion.
The decline in net profit was affected by changes in the valuation of Google's investment assets, whose investment portfolio includes equity in SpaceX. The valuation of SpaceX, the rocket manufacturer owned by Elon Musk, fell by about 4% during the reporting period, causing Google to record a net loss of US$8.7 billion in equity investments.
Operating profit excluding investment losses rose 30% year-on-year to $40.6 billion, but was still below Wall Street expectations of $43.2 billion.
Ashkenazy noted that the company's $5.2 billion cash payment to settle a European regulatory fine stemming from 2018 also exacerbated negative free cash flow.
Google recently lost a lawsuit. The lawsuit related to its anti-competitive behavior through the Android operating system, and the company's appeal against the relevant ruling was not supported.
Cloud business is growing strongly, but artificial intelligence strategy still faces challenges
Part of the benefit that offsets the weakness in search business came from Google Cloud business. Google Cloud revenue doubled to $30.7 billion in the third quarter, driven by surging customer demand for Google's own artificial intelligence services and the sale of computing power to rivals such as Anthropic.
Google has always regarded its "full-stack" artificial intelligence strategy as an important competitive advantage. The company independently develops chips, builds data centers, trains cutting-edge models, and then provides these technologies to billions of loyal users through existing applications and services.
However, CEO Sundar Pichai has been criticized by critics for being slow to deploy artificial intelligence, leaving a company as massive as Google lagging behind startups such as Anthropic and OpenAI in the lucrative enterprise market.
Pichai said that two new versions of Google's most advanced Gemini models - Argon and Carbon - have narrowed the gap with competitors in the fields of programming, finance and network security, and are expected to help Alphabet regain market share.
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