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Alphabet beats earnings targets, but investors worry about increased AI spending

Google LLC’s parent company Alphabet Inc. reported second-quarter earnings and revenue that surpassed expectations, but surprised investors when it said it’s going to increase its capital investments in fiscal 2025 by an additional $10 billion.

The company reported earnings before certain costs such as stock compensation of $2.31 per share, surpassing the $2.18 estimate from analysts. Meanwhile, revenue increased 14% from a year earlier, to $96.43 billion, ahead of the Street’s $94 billion target. That meant Alphabet posted total income of $28.2 billion in the quarter, up 20% from the same period last year.

Alphabet’s stock initially rose more than 3% in after-hours on the report, only to reverse most of those gains quickly when investors became aware of its increased spending plans. The company told analysts that its investments in artificial intelligence this year are going to cost more than first anticipated, and consequently bumped up its annual capital expenditures forecast to $85 billion, up from $75 billion earlier.

Originally, Alphabet executives said in February that the company anticipated spending $75 billion in capex this year, but it turns out that’s not going to be enough.

In a conference call with analysts, Alphabet Chief Financial Officer Anat Ashkenazi said the increase is from “strong and growing demand for our cloud products and services.” She added that there will likely be additional new expenditures in fiscal 2026, but didn’t put a number on those increases.

One analyst asked Ashkenazi about Alphabet’s increased spending on AI talent, which has risen to billions of dollars this year. In the most recent example, earlier this month, the company said it would bring aboard Windsurf Chief Executive Varun Mohan and other leading researchers from the AI coding startup after spending $2.4 billion on a technology licensing deal.

“We make sure that we invest appropriately to have the best and brightest minds in the industry,” Ashkenazi said.

As to when such investments will pay off remains unclear, but Alphabet CEO Sundar Pichai (pictured) said on the call that AI Overviews, the company’s search engine bot that summarizes user’s search results, now has more than 2 billion users across over 200 countries and territories, up from 1.5 billion users at the end of the previous quarter. Meanwhile, the Gemini app that provides access to Google’s large language model-based chatbot, now counts more than 450 million active users, Pichai added.

The addition of AI Overviews to Google Search may be one reason why that business continues to show strength. It brought in more than $54.19 billion in revenue during the quarter, representing a good chunk of its overall $71.34 billion in advertising revenue. That was up 10.5% from $64.61 billion in ad sales in the same period last year.

Holger Mueller of Constellation Research Inc. said the latest results appear to put to bed any fears that generative AI might have an impact on Google’s dominance of search, at least for now. “So long as Google keeps innovating with its own AI-generated searches, that seems unlikely to happen,” he said.

The company also reported YouTube ad revenue of $9.8 billion, coming in slightly higher than Wall Street’s estimates.

As for Google Cloud, the fast-growing cloud infrastructure business, revenue there hit $13.62 billion in the quarter, up 31% from a year earlier. Last week, the business received a major boost when OpenAI said it’s going to start using Google Cloud’s infrastructure resources to support ChatGPT. “We’re very excited to be partnering with them” was all Pichai would say about the deal today.

The explosive growth of Google Cloud and the addition of OpenAI are yet more evidence that enterprises are finally waking up to the fact that it has a three-to-four-year lead when it comes to putting custom algorithms, namely Tensorflow, onto customer hardware in the shape of Google’s TPUs, Mueller said. “Additionally, Google Cloud has a one-year lead in terms of operating multimodal models, and it adds up to better and cheaper AI infrastructure in many cases,” the analyst pointed out. “It’s a powerful formula that gives Google a significant advantage in the race for AI in the cloud.”

Forrester Research Inc. analyst Lee Sustar told SiliconANGLE that Google Cloud’s growth in the last few years has been compelling, and says that what was once seen as just a sideline beset with enormous losses has been transformed into an increasingly significant earner. “AI is a big reason, but not the only reason for this gain,” he said. “Google Cloud has systematically built out wide enterprise compute capacity beyond its signature data, analytics and AI offerings.”

The analyst also pointed to Google Cloud’s operating margin, which doubled to about 20% in the quarter, showing that the business can grow without burning up all of the revenue it generates in its vast AI investments. “The era of AI-native cloud is here and it’s showing up in Google Cloud’s numbers,” Sustar said.

As for Alphabet’s Other Bets segment, which includes the self-driving car unit Waymo, the life sciences business Verily and other experimental products and services, that generated $373 million in revenue, up slightly from a year earlier when it reached $365 million in sales. It’s still hugely unprofitable, though, with its net loss coming to $1.25 billion, up from $1.13 billion a year ago.

Alphabet’s total operating expenses rose 20% from a year earlier, to $26.1 billion. According to Ashkenazi, this was partly from the company’s increased legal expenses, which included a $1.4 billion charge from a settlement with Texas Attorney General Ken Paxton that was finalized in May, relating to a data privacy rights lawsuit dating back to 2022

The company didn’t offer guidance for the current quarter, but Ashkenazi told analysts that the company could see some headwinds as a result of several factors, including a negative impact on YouTube ad revenue, following “strong spending on U.S. elections” last year.

Investing.com senior analyst Jesse Cohen said investor sentiment on Alphabet seems mixed in the wake of the report, likely because of the big increase in its capex forecast. On the one hand, it demonstrates a commitment to maintaining a competitive edge in AI, but on the other hand, it creates concerns about the company’s near-term profitability, he explained.

“The market is questioning the pace of monetization, and the ROI may initially weigh on short-term margins,” Cohen said. “But we expect the investments to enhance Google’s product offerings and operational efficiencies within two to four years. Balancing these investments with effective execution and innovation will be essential for achieving a favorable ROI while maintaining investor confidence.”

Photo: Philippe Masse/Flickr