Alphabet’s cloud problem is raining on Google’s parade

Despite beating expectations and posting an 11% year-over-year growth in revenue on the back of rebounding advertising spending, Alphabet saw its stock drop in after-hours trading following its earnings report for the third quarter of 2023 thanks to weaker-than-expected performance in the company’s cloud business.

Alphabet shares fell by more than 6% following its earnings report after rising nearly 2% during regular trading hours on Tuesday.

Google’s parent company posted a net income of $19.69 billion for the quarter, topping the $18.52 billion expected. Revenue reached $76.69 billion, topping analyst estimates of $75.95 billion.

Advertising and YouTube were the big growth drivers for Alphabet this quarter, with ad revenue hitting $59.65 billion—up 9% year-over-year. Given that the company was watching its ad business shrink earlier this year, the latest earnings report seems to signal a turnaround.

YouTube ad revenue grew 15% to $7.95 billion, driven in part by the growth of YouTube Shorts, the company’s answer to TikTok and Instagram Reels. Shorts now sees more than 70 billion daily views, according to Alphabet CEO Sundar Pichai—up from 50 billion at the start of the year.

While ad revenue was strong, Alphabet’s underperforming cloud business seems to be stuck in Wall Street’s craw. The company reported $8.41 billion in revenue from its cloud division, which represents a 22% increase over the third quarter of 2022, but fell short of expectations by about $20 million.

What about AI?

Pichai spent much of the earnings call touting Alphabet’s artificial intelligence products, including the company’s Search Generative Experience (SGE), which uses generative AI to provide conversational-style responses to search queries. Pichai also talked up a new suite of AI tools for YouTube creators, which rolled out last month. He pointed to those AI innovations as areas for potential growth.

Similarly, he suggested AI would be key to growing the company’s cloud business, positioning Google Cloud as the key platform for generative AI startups that need significant computing power to run their operation.

However, finance chief Ruth Porat said on the call that the lower-than-expected revenue in the third quarter “reflects the impact of customer optimization effort”—suggesting clients are spending less on these services.

Alphabet faces stiff competition in the cloud space from such services as Microsoft Azure and market leader Amazon Web Services (AWS)

While it’s clear that Alphabet is investing heavily in AI across the board, it’s the company’s traditional businesses (the ones that have the company in court fighting an antitrust case brought by the U.S. Justice Department) that continue to lift its bottom line.

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