Alphabet Earnings Miss Spotlights First Cracks in Search Business as AI Gains Ground

Alphabet's latest quarterly results missed expectations across every segment, but one number drew the most attention: search. Revenue in the search and other segment rose 12% year over year to roughly $63 billion, falling short of estimates for the second consecutive quarter. Yet Google said search query growth was the strongest it has seen in five years.

That widening gap between how much people search and how much Google earns from it is getting harder to explain away as more users turn to AI bots and agents, including Google's own tools. Analysts have warned since ChatGPT's arrival that traditional search could be eclipsed by AI and that Google would need new ways to make money. Search remains a huge business, but early signs of a shift are emerging.

"These things are going to be a force," Gene Munster of Deepwater Asset Management told CNBC's "Fast Money" after the report, referring to AI-powered services. He said that if personalized bots take off, "that will become for a lot of people the starting point of commerce, which impacts where Google is."

Alphabet executives attributed the search revenue deceleration mainly to foreign exchange, and said the currency impact would be even larger in the fourth quarter. The stock fell about 10% in extended trading, reflecting the weak report and negative free cash flow of $9 billion for the quarter, three times the estimated deficit. In the prior quarter, free cash flow turned negative for the first time in Alphabet's history as a public company, at $5.9 billion.

Google has spent much of the past year telling investors it must pour money into AI infrastructure and services to meet relentless demand. Its Gemini model has kept the company competitive with Anthropic and OpenAI, and Gemini-powered enterprise services have resonated with customers. The company also says Gemini is strengthening its core ads business by improving how well it understands user intent and targets advertising.

"We continue to accelerate the deployment of Gemini models across our entire ads infrastructure to boost performance," Chief Business Officer Philipp Schindler said on the earnings call. He called the third quarter's product listing ads update the "biggest" in a decade, adding new AI capabilities. "Overall, AI is accelerating our ads development and drives the majority of our product launches," he said. Advertisers used Gemini models to generate more than 1.5 billion campaign assets in the quarter, up more than sevenfold from a year earlier, according to Schindler.

None of that resolves the search revenue trend, which slid from 19% growth in the first quarter to 17% in the second and 12% in the third. UBS analysts wrote that the results are "going to bring Search cannibalization fears right back to the forefront." Mizuho analyst Jordan Klein said the numbers pose an issue for search and YouTube, writing that they "elevate the fear around AI and agentic taking share from Search and YT and hurting their AI monetization narrative."

Where Alphabet's AI bet is clearly paying off is cloud. Revenue in the division, racing to catch up to Amazon Web Services and Microsoft Azure, more than doubled in the quarter to nearly $31 billion. Cloud backlog reached roughly $560 billion, reflecting enormous contracted demand for AI infrastructure, with management expecting just over half of it to be recognized over the next 24 months. Microsoft, reporting the same day, said Azure revenue rose 48% to $33.2 billion.

Cloud demand is a major reason Alphabet keeps spending. The company maintained its full-year 2026 capital expenditure forecast of $195 billion to $205 billion and said spending will rise significantly in 2027. Some of that goes to its tensor processing units, which compete with Nvidia's graphics processors and which Alphabet began selling to outside customers in the second quarter. Customer agreements first appear in Google Cloud's backlog, and the company must build systems before delivering them and booking the revenue.

"You see cash going out and we're building up the inventory base," CFO Anat Ashkenazi said on the call. "As we start delivering and billing customers for these TPU systems, then you see cash coming in."

Still, Google must reckon with concerns about its longtime cash cow. Gil Luria of D.A. Davidson said fears that dates from 2023 to 2025 about AI's effect appear to finally be surfacing in Google's business. "Investors will now worry that the miss in Search, YouTube and Subscription, leading to a profit miss, are an indication that AI has finally come for Google," Luria wrote in an email. "We would not rush to conclusions based on one quarter, but will definitely need to reassess what the world of agentic commerce means for Google."

Source: CNBC