Search sales growth rate 17%→12%… YouTube advertising growth also weakens
Facility investment of $51.4 billion, free cash flow deficit for two consecutive quarters
Google's parent company, Alphabet, saw its stock price plummet after announcing its earnings despite the rapid growth of its cloud business. While the growth rate of the main advertising business has slowed, facility investment expenditures centered on artificial intelligence (AI) infrastructure have exceeded cash earned from operations. Although demand for AI led to increased sales, financial burden due to large-scale investments was also revealed.
Alphabet announced on the 28th (local time) that its sales in the third quarter of this year were $127.577 billion, a 25% increase compared to the same period last year. It fell short of the LSEG market estimate of $128.2 billion reported by Reuters. After the earnings release, Alphabet A-shares (GOOGL) and C-shares (GOOG) fell by about 10% at one point in after-hours trading.
In the advertising business, sales growth rates for both search and YouTube decreased. Search and other advertising revenue was $63.35 billion, up 12% from the same period last year, but slower than the 17% increase in the second quarter. YouTube advertising sales also increased 9% to $11.27 billion, down from 13% in the previous quarter.
The company pointed to the exchange rate as the biggest factor in the slowdown in search sales growth. He added that advertising execution, which had increased due to the World Cup, has normalized, and that the EU's abolition of duty exemptions for small-value imported goods also affected some retail advertisers in the Asia-Pacific region.
In AI search, there remains the task of connecting increasing usage to advertising revenue. CEO Sundar Pichai said that the year-on-year increase in overall search queries was the highest in the past five years. However, Chief Business Officer (CBO) Philip Schindler explained that the relatively low level of monetization in AI mode dragged down the growth rate of search sales. The company is expanding the scope of advertising applications for AI Overview and AI Mode under the policy of prioritizing improvement of user experience.
In the corporate cloud, AI investments showed results. Google Cloud sales increased 103% year-on-year to $30.79 billion, and operating profit more than tripled to $11.121 billion. Demand for enterprise AI infrastructure and solutions and sales of the tensor processing unit (TPU) system, its own AI semiconductor, led the growth.
Consolidated operating profit also increased by 30% to $40.576 billion. On the other hand, net profit attributable to common stockholders decreased by approximately 25% to $26.17 billion. Pre-tax equity securities investment loss was $8.664 billion, reducing net profit by about $6.7 billion. Chief Financial Officer (CFO) Anat Ashkenazi cited valuation losses on SpaceX shares as the main cause of the deterioration in non-operating profits and losses.
Cash flow was hampered by facility investment. Cash flow from operating activities in the third quarter was $42.29 billion, but $51.355 billion was spent on facility investment. Free cash flow, the difference between the two amounts, was negative $9.065 billion, recording a deficit following the second quarter.
In addition to facility spending, securing inventory and paying fines also put a strain on cash flow. According to the company, inventory has increased as it prepares to sell the TPU system. In addition, $5.2 billion was paid as the appeal process for fines imposed by the European Commission (EC) was completed in 2018.
Alphabet maintained its facility investment forecast for this year at $195 billion to $205 billion, and expected the investment amount to increase significantly next year. To meet computing demands, we began utilizing external computing capacity at the end of the third quarter, and plan to increase the scale of utilization in the fourth quarter. Accordingly, the cloud division's profit margins may be under pressure in the short term. Data center operating costs, such as depreciation and power costs due to increased infrastructure investment, were also presented as a performance burden factor.
Investing.com, a financial information media, reported on the 29th that Barclays lowered Alphabet's target stock price from $425 to $405, but maintained its investment opinion of 'overweight'. Ross Sandler, an analyst at Barclays, evaluated cloud growth positively, but said there was uncertainty about the process by which increased use of AI search leads to advertising revenue. The investment appeal of stocks remains, but the stock price may be under pressure for the time being.