Alphabet (GOOGL) just reported second-quarter earnings, and everyone, everywhere is now an expert in search traffic and AI capital expenditures. Congratulations, everyone on the internet who is now able to add that to their resume.
I’ve read through the presentation slides, and skimmed the broader report itself. The company topped the headline revenue estimate, annihilated expectations in Cloud, and reported record quarterly operating income. Its cloud business continues to do well, and it raised about $70 billion to fund AI and other plans the same quarter that its free cash flow went negative…
Let’s look at the Good… the Bad… and the WTF…
Alphabet’s consolidated revenue registered around $119.8 billion, a 24% bump from last year. That’s the 12th straight quarter of double-digit revenue growth, something that is rarified air for a business of this scale.
Search did increase by 17%, while YouTube Ads, which I still don’t understand as a functioning ecosystem, jumped 13%. Those ads generated about $11.1 billion, making their deal for YouTube one of the greatest acquisitions in business history.
The Google Services segment generated $94.5 billion, a 15% gain from last year.
Then there is Google Cloud, which knocked the ball out of the park again. Its revenue increased by another 82% from last year to hit $25 billion. Margins were strong…
And it’s sitting on a big backlog of about $514 billion thanks to the fact that 90% of Fortune 100 companies are using the Gemini Enterprise product. Its Gemini app reached 950 million active users this month, and the CEO said that its AI models are processing about 22 billion tokens every minute…
I don’t think I can picture a billion of anything being processed or happening every minute… so I’m just gonna tip my hat and move on with this article.
Now, We Look at the Bad…
So, imagine that you go to pull out a credit card at checkout… and then you pull out a second card at checkout to pay for the first one. Then, you realize that your shopping card keeps filling up randomly where you’re just standing there…
That’s basically Alphabet’s cash flow practices right now. The company spent nearly $45 billion on physical things in the quarter. That was a 100% jump from last year, and it’s been part of an ongoing shopping habit lasting the last five quarters… Each spending bill has been larger and more meaningful than the previous one…
What are they spending it on?
Stuff… Things like land (there will be a rush on Finnish land in the northern parts….) and buildings… and servers… and the type of concrete that the guy down the street from me sells to keep data centers from melting… and sinking.
They’re spending more on physical infrastructure every quarter than the entire market capitalization of hundreds of publicly traded companies…
And it’s only going up… which sets new expectations that this boom is sustainable.
What would make it unsustainable? Eventually, you run out of money…
And Alphabet’s free cash flow - (this is where operating cash generation meets its surging capital expenditures) - went negative for the quarter at MINUS $5.9 billion.
Last year, that figure was positive at $5.3 billion. On a trailing 12-month basis, their free cash flow has dropped by about 20%. Their quarterly capex is swallowing their quarterly operating cash flow.
Yes, the underlying business is extremely profitable… but the spending has changed the shape and layout of expectations for the company moving forward…
Which Leads Me to WTF?
The company has $70 billion of fresh capital… and they raised it by smartly taking advantage of their record stock price. This flow comes in $50 billion in stock and preferred issued in June, and another $20 billion of senior unsecured bonds.
They also established another $40 billion at-the-market stock program that hasn’t been tapped and can cover taxes linked to employee stock grants. None of that money goes to the AI buildout itself…
This is a stark shift in cash flow management for this company. Over the last decade, Alphabet has been returning cash to shareholders through stock buybacks… so all of this buildout and new capital raising is a different way of thinking about money for them.
The company didn’t repurchase any stock this quarter, down from the $13.2 billion in buybacks that it completed last year at this time. That’s important not just to Alphabet, but also to the broader market, which has had expected this flow of buying support.
Now, consider one last thing that I might need some clarity on… and a little more investigation into the evening. Alphabet’s net income for the quarter was $112.1 billion… which is massive. About $98 billion of that pre-tax income showed up in this “other income, net”… and there was another $99 billion in net gains on equity securities…
So… those equity gains added $77.1 billion to net income and about $6.26 to its $9.11 in earnings per share. That means almost 70% of their quarterly net income came from investments in other businesses… That includes gains on names like SpaceX after the company’s public listing…
It’s important to note how all of these massive Silicon Valley giants didn’t just become massive beneficiaries of capital flows in the last decade.
They also became venture capitalists with their own investment arms. In 2022, as interest rates rose and external VCs took it on the teeth… big Silicon Valley names didn’t have to borrow money… they could just use their existing cash flow to bankroll technology ventures and compete against some of the biggest names in finance for new ideas.
This is a story that still remains largely unexplored and shifted the power brokerage even more to these concentrated names in the markets.
I’ll be back in the morning to talk more about the report… but also lay out how investors should approach this. Our momentum signal is currently negative…
And GOOGL is down 4% as futures click on right now…
Comments
Log in or sign up to join the conversation.