Alphabet’s Shares Drop as Investors Wait for AI to Pay Off

(Bloomberg) — Alphabet Inc. shares fell after the Google parent sunk more resources into its drive to outmatch rivals in artificial intelligence, fueling spending higher than analysts expected.

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Capital spending rose to $13.2 billion in the second quarter, supporting Google’s AI programs and computing power needs, the company said Tuesday. That exceeded analysts’ estimates of $12.2 billion.

Google once had a head start in the AI race because it developed much of the technology underpinning popular chatbots. Now, the company is under pressure to prove that it can withstand competition from the likes of OpenAI and Microsoft Corp. as they try to draw people away from traditional web search, pushing chatbots that can answer users’ questions in a conversational fashion.

Google has rushed to weave artificial intelligence into all of its widely used products, including Gmail, Google Docs and search, while boosting its own AI capabilities — an expensive initiative with mixed results. Some investors are looking for clearer evidence of return on investment for all the billions in spending on AI progress, said Daniel Morgan, senior portfolio manager at Synovus Trust.

“How much revenue are you getting from that?” he said. “When I look at this report what I see is Google as it’s always been. They generate money from advertising and search.”

Alphabet shares fell 4% at 9:45 a.m. in New York on Wednesday. The stock had closed at $181.79 and is up 30% this year.

Investor concerns around Alphabet’s spending detracted from better-than-expected sales in the quarter, which were boosted by demand for cloud-computing services and serch advertising revenue.

Sales, excluding partner payouts, were $71.36 billion in the second quarter, the company said in the statement. Analysts had projected $70.7 billion, according to data compiled by Bloomberg. Net income was $1.89 per share, compared with Wall Street’s $1.84 per-share estimate.

Google Cloud brought in profit of $1.17 billion, beating analysts’ estimates for operating income of $982 million. Google still trails Amazon.com Inc. and Microsoft in the cloud computing market, but in the past year, the unit has attracted business from artificial intelligence startups. Investors are also eyeing Google Cloud as the unit with the most potential to boost growth at Alphabet overall, especially as its search business matures.

“We’ve certainly seen the benefit of our strength in AI, AI infrastructure, as well as generative AI solutions for cloud customers,” Alphabet Chief Investment Officer Ruth Porat said on a call with media. “There is no question customers are turning to us as they are building out their capabilities.”

In May, Google announced AI Overviews for search written by generative artificial intelligence technology, but the launch of the feature didn’t go well. Some AI Overviews offered embarrassing suggestions, advising people to eat rocks or to put glue on pizza, for example. Still, quarterly search advertising revenue was $48.5 billion, compared with the average analyst projection for $47.6 billion.

“If it takes more effort for consumers to go anywhere else to search,” said Evelyn Mitchell-Wolf, an analyst with EMarketer, “Google is going to keep monetizing search traffic higher than any of its competitors.”

YouTube reported $8.66 billion in revenue, compared with analysts’ average estimate of $8.95 billion. Of Alphabet’s various businesses, YouTube has been the most vulnerable to swings in the digital-ad market.

Alphabet’s Other Bets — a collection of moonshot units that includes the life sciences business Verily and the self-driving car effort Waymo — brought in $365 million in revenue while posting an operating loss of $1.13 billion. That was steeper than analysts’ projection for a loss of $1.07 billion. Alphabet has recently put pressure on its bets to spin off as independent startups, rather than becoming business units of their parent company.

In its latest report, Alphabet indicated that it has $100.7 billion in cash, equivalents and marketable investments, down from the $108 billion it reported in the first quarter. In recent months, Google showed interest in acquiring two companies, either of which would have been the biggest-ever purchase for the internet giant — but both times, the deals fell apart. The acquisitions, for HubSpot Inc. and Wiz Inc., would have strengthened the company’s cloud and cybersecurity offerings, helping it to compete with its tech rivals.

“We are always looking for good opportunities to diversify the portfolio and will continue to do so if we find the right combination of factors, including value,” Porat said, without commenting on the Wiz talks. “Regulatory scrutiny is not new for us, and we have successfully managed regulatory reviews of many large deals in the past.”

Later this month, Anat Ashkenazi, a veteran Eli Lilly & Co. executive, will join the search giant as chief financial officer. Porat, Alphabet’s longest serving CFO, will stay on as president and chief investment officer, spending more time working on the company’s portfolio of other bets.

–With assistance from Ed Ludlow and Shona Ghosh.

(Updates share price.)