Alphabet's third-quarter earnings painted a starkly contrasting picture of its two major business segments, signaling a potential transformation of the tech giant's identity. While Google Search, the company's traditional cash cow, experienced a notable slowdown in growth, its cloud division surged ahead, underscoring the growing importance of artificial intelligence infrastructure.
Search advertising revenue grew by 12% year-over-year, a deceleration from the 17% growth seen in the second quarter and below the approximately 14% that analysts had anticipated. This marked the first time that Google Search accounted for less than half of Alphabet's total revenue, a symbolic milestone that suggests the company's reliance on its flagship product is waning.
In stark contrast, Google Cloud sales more than doubled to $31 billion, lifting the segment's contribution to Alphabet's top line to 24%, up from 15% a year earlier. The company highlighted strong demand for its tensor processing units (TPUs), its custom AI chips, and noted that its Gemini models are leading at the frontier. The Gemini app has also reached one billion users, making it the fastest-growing product in Google's history.
Alphabet attributed the slowdown in Search growth primarily to foreign exchange headwinds, but executives also acknowledged that AI-powered Search features have played a role. Philipp Schindler, Alphabet's chief business officer, noted that AI Overviews have impacted monetization, as queries conducted through AI Mode are on average three times longer but generate lower revenue for now.
The financial strain of heavy AI investment was evident in Alphabet's free cash flow, which came in at negative $9.07 billion, significantly worse than the $2.70 billion analysts had expected. The company maintained its fiscal 2026 capital expenditure guidance of $195 billion to $205 billion and indicated that spending would increase substantially in fiscal 2027. This news sent Alphabet's stock down roughly 13% in its worst single-day drop, erasing approximately $475 billion to $511 billion in market value.
Investors are now grappling with a narrative that AI is both a boon and a threat. Dan Ives, an analyst at Yorkville Ives, noted that this is the first quarter where the negative thesis around AI crushing search has legs. The company plans to scale advertising within its AI Overviews and AI Mode products, but the question remains whether Alphabet will gradually become known less for Google Search and more as a cloud infrastructure company.
Google Cloud's turnaround has been remarkable. After years of losses, it turned its first profit in 2023, and generative AI is now accelerating its growth. While Amazon remains the global cloud leader with about 31% market share, and Microsoft's Azure holds about 20%, Alphabet is making a case that it can take the AI lead. David Wagner of Aptus Capital Advisors told Invezz that query growth was the strongest in five years, but Alphabet isn't getting paid as much per query yet, which is the cannibalization investors fear.
Analysts see Google Cloud becoming a major earnings driver. Rosenblatt expects Google Cloud revenue to surpass the combined revenue of Search and YouTube by 2028. JPMorgan's Doug Anmuth believes Cloud will drive overall Alphabet revenue growth of approximately 30% in both 2027 and 2028. Morningstar's Malik Ahmed Khan noted that Cloud's backlog is five times its annualized quarterly sales, providing significant visibility.
As Alphabet navigates this transition, the market will be watching closely to see if the company can preserve its advertising economics while scaling AI-driven search and cloud services. The shift in revenue mix is undeniable, and the long-term implications for Alphabet's valuation and business model are profound.
This article is for informational purposes only and does not constitute financial advice.
