Alphabet falls as margin fears, YouTube slowdown eclipse AI boost

By Aditya Soni and Khushi Singh

(Reuters) -Alphabet fell more than 3% on Wednesday on fears that its rising investments in AI infrastructure would squeeze margins and YouTube was facing tough competition for ad dollars.

The Google parent's capital expenditure rose more than expected in the second quarter to $13.2 billion as it invests heavily in infrastructure needed to support generative AI services, as well as compete with Microsoft.

While Alphabet has been cutting costs through layoffs to protect profitability, several analysts said that seasonally higher hiring of fresh graduates and the earlier-than-usual Pixel launch will weigh on its margins in the third quarter.

Its YouTube video-streaming service is also grappling with tough year-on-year comparisons and competition in the market for online ad videos from the likes of Amazon.com.

YouTube ad sales grew 13% in the second quarter, compared with an increase of nearly 21% in the first quarter.

"Management sounded quite conservative about the outlook for the second half of the year," Bernstein analysts said.

"Perhaps this is Google's way of setting an easy bar for the new CFO to come in against the next quarter. Or perhaps there's some truth to the conservatism and we are entering an uncomfortable period for the digital advertising names with decelerating growth and rising costs."

Shares of other digital ad-reliant firms such as Meta Platforms, Snap and Pinterest were down between 3.2% and 4% as growth slowed at Alphabet's core Search business despite beating estimates.

Alphabet was on track to lose around $60 billion in market value on Wednesday. Its stock has gained about 30% so far this year, benefiting from the rally in AI-related stocks.

Despite the drop, many analysts were positive on Alphabet, pointing to signs that its AI efforts were driving up cloud revenue and that there was little disruption to Search revenue from the AI overviews it rolled out widely earlier this year.

Revenue from cloud computing services rose 28.8%, faster than expectations, in a positive sign for enterprise spending.

"We continue to view Google as an AI winner and find core product improvements encouraging," Piper Sandler analysts said.

At least 25 brokerages raised their price targets on the stock, pushing up the median view to $204. Alphabet's 12-month forward price-to-earnings ratio stands at 22.2, compared with AI chip firm Nvidia's 38.6, according to LSEG data.

(Reporting by Aditya Soni and Khushi Singh in Bengaluru; Editing by Shounak Dasgupta)