Google fails to wow as AI costs soar

Parent company Alphabet reported second-quarter results on Tuesday afternoon that showed strong advertising and cloud revenues and a record operating profit. The Silicon Valley giant once known for its lavish employee perks continues to keep most expenses in check, except for some spending aimed at building out its artificial intelligence generation capabilities.

But the results were “less than exciting,” in the words of Jefferies analyst Brent Till. Total revenue beat Wall Street's consensus estimate by just 0.6%, the lowest beat in five years, according to FactSet. YouTube advertising revenue also missed analysts' expectations. Alphabet's last earnings report, released three months ago, included a bigger positive surprise on both revenue and profit growth, as well as the company's first-ever dividend announcement. Alphabet's shares have risen nearly 17% since those results were released and were down about 2% in after-hours trading on Tuesday.

Tuesday's results also signal that the second half of the year may be tougher. For one, comparisons will be tougher because Google was mostly recovering from its advertising slump in the second half of last year. Also, Google only really ramped up spending on AI infrastructure in the second half of 2023. Capital expenditures in the first half of 2023 will be less than half of the $25.2 billion the company spent in the first half of this year.

The spending isn't likely to stop anytime soon, even as Google cuts other costs and reduced its workforce by more than 1,300 people in the most recent quarter. Alphabet said Tuesday that capital expenditures in the second half of the year are likely to be more than $12 billion per quarter, for a total of more than $49 billion for the year, 84% higher than the company's average annual spending over the past five years.

“As you can see, we're clearly in the early stages of what we see as a very transformative space,” Alphabet CEO Sundar Pichai said on an earnings call on Tuesday when asked by an analyst about the company's AI investments. “For us, the risk of underinvesting is significantly greater than the risk of overinvesting,” he added, without mentioning that tech rivals Microsoft, Amazon and Meta Platforms are pouring record capital spending into the same space.

Google has resources. Alphabet's net cash balance of nearly $98 billion is significantly larger than that of its deep-pocketed peers. But putting that money to work is becoming harder. The Wall Street Journal reported Monday that Google's talks to buy cybersecurity startup Wizz have fallen apart. The deal, reportedly worth $23 billion, would be Google's largest ever and is sure to have triggered the kind of intense regulatory scrutiny that has seen recent tech mergers hang in the balance for more than 18 months. Such uncertain payoffs have reportedly been a concern for Wizz and its investors. Google bought Fitbit for less than a tenth of that amount in 2021, but the deal took nearly 15 months to close.

Google is also scrapping long-term plans to phase out its use of internet tracking technologies known as “cookies,” which are disliked by privacy advocates but relied on by advertisers. Google had been developing an alternative called “Privacy Sandbox,” but the plan drew strong opposition from advertisers and regulators who worried it would further cement the company's grip on internet advertising. Google said Monday that it would instead prompt users to opt out of cookie tracking.

The move is unlikely to deal a blow to Google's powerful search-advertising business. But it and the failed negotiations with Wizz show the company is increasingly under constraint as regulators scrutinize the positions of big tech companies more closely and judges and juries begin to hand down decisions. A decision in the federal antitrust case against Google is expected by the end of the year and could lead to a ruling that calls for breaking up the $250 billion-a-year advertising giant.

Google's latest results were good, but good isn't always good enough.

Write to Dan Gallagher at dan.gallagher@wsj.com