In this post, we take a deeper look at Google’s earnings results for Q2 and share our thoughts on:<\/p>\n
On May 7th of this year, during the Department of Justice\u2019s antitrust trial against Google, Apple’s Senior Vice President of Services, Eddy Cue, revealed in his testimony that Safari searches declined for the first time in 22 years. Mr. Cue attributed the decline to the rising popularity of AI-powered search and assistants such as OpenAI\u2019s ChatGTP, Perplexity AI, xAI\u2019s Grok, and Anthropic\u2019s Claude. On the topic of the eventual transition from traditional search to AI-powered alternatives, Cue added, \u201cThere\u2019s enough money now, enough large players, that I don\u2019t see how it doesn\u2019t happen.\u201d<\/p>\n
In response, shares of Alphabet fell 9%, erasing an estimated $140 billion in market value.<\/p>\n
Since then, investors have been awaiting Alphabet\u2019s Q2 earnings to provide clarity around the issue\u2014and it has, at least for Google\u2019s Search business. But other questions remain in terms of one area Google is losing major real estate, which we discuss below.<\/p>\n
Search reported 12% YoY revenue growth of $54.2 billion, helping drive Alphabet\u2019s total revenue to $96.4 billion, up 14% YoY. While OpenAI\u2019s ChatGPT, Perplexity\u2019s new Comet browser, the Department of Justice, and others deserve continued monitoring, Google\u2019s resilience in this space is impressive.<\/p>\n
On the Q2 earnings call, Alphabet stated that Google is successfully integrating AI Overviews into its core search experience. With 2 billion monthly users across 200 countries, AI Overviews contribute 10%+ additional queries for the searches in which they appear. For Google, this represents a value add and engagement driver, not a disruption.<\/p>\n
Google\u2019s Gemini and ChatGPT are battling to become the AI assistant of choice for consumers. To compare, Gemini has reached 450 million MAUs, up 100 million from March of this year, with daily requests surging 50% over Q1. But according to Google\u2019s own data shown in court back in March of this year, ChatGPT had an estimated 600 million MAUs, and likely many more by now. Gemini is gaining ground, though still lags behind ChatGPT.<\/p>\n
Alphabet also reported on its launch of AI Mode\u2014a new option displaying as the first tab in Google\u2019s main search menu, next to All, News, Videos, Images, and the rest\u2014in the U.S. and India. The company said AI Mode has already amassed 100 million MAUs.<\/p>\n
Capex Now 40% Higher Since the Start of 2025<\/p>\n
While Google Cloud revenue reaccelerated four points to 32% to $13.6 billion\u2014a welcome beat considering Q1 had seen a 2-point sequential deceleration \u2014the big news on Cloud is the reported $10 billion increase to capex, now up to $85 billion. This is 40% higher than the $60 billion capex estimate coming into the year, signaling Alphabet’s willingness to spend on AI to drive accelerating cloud growth.<\/p>\n
Similar to Oracle stock<\/a>, this surging capex is weighing heavily on free cash flow, and will likely continue to pressure free cash flow in the upcoming quarters. Operating cash flow rose just 4% YoY to $27.7 billion in Q2, yet free cash flow declined (61%) YoY to $5.3 billion. While TTM free cash flow is still up 10% YoY to $66.7 billion, the market is forward looking, and this capex hike implies TTM free cash flow will continue to trend much lower over the next few quarters.<\/p>\n It is understandable why Alphabet is willing to increase its capex, as it is beginning to witness increasing operating leverage in Google Cloud and seeing AI usage proliferate across its core Search business. For example, AI Overviews now serves 2 billion users and processes 980 trillion tokens monthly, doubling since May, a scale which helps explain the explosive compute costs driving Google\u2019s massive investment in Cloud.<\/p>\n Cloud operating margins have expanded significantly, up more than nine points from 11.3% to 20.7%, as operating income rose 141% YoY to $2.8 billion. Prioritizing AI investments in an effort to drive Cloud growth of >30% could see the segment reach a $120 billion run rate by mid-2028, more than double its $54 billion run rate this quarter. Should operating margins begin to expand towards the high-20% to 30% level by mid-2028, versus AWS in the high-30% range, Cloud could generate $30 billion in annual operating income, or more than 3x from today.<\/p>\n This represents more than one-quarter of current company-wide operating income, or a potential massive driver of profitability in the future — the point here is that Alphabet is essentially sacrificing some FCF growth in the near-term and spending heavily in an aim to reap the rewards of a much larger, fast-growing Cloud segment in the future.<\/p>\n Another market reality adding pressure to Google\u2019s Cloud and AI initiatives is the fact that Microsoft Azure has already set a high bar and is leading the race to monetization by a substantial margin. Whereas Google processes huge volumes of tokens\u2014980 trillion, a figure that has doubled since May of this year\u2014Microsoft\u2019s deeply established enterprise relationships with hundreds of millions of users has unlocked user and revenue growth.<\/p>\n Microsoft\u2019s fiscal Q3 report helped cement the company as the strongest AI player in the hyperscale crowd due to its focus and dominance across enterprise software offerings and deep AI integrations aided by its partnership with OpenAI.<\/p>\n<\/p>\n I\/O Fund covered Microsoft\u2019s impressive Q3 2025 earnings and Azure\u2019s outperformance on May 15th, which you can read for free here: Microsoft Stock Surges After Q3 2025 Earnings: What Separates Azure from AWS, Google Cloud<\/a>\u00a0<\/p>\n One Serious Concern Remains for Google\u2019s Stock<\/p>\n The intense regulatory pressure on Google to open its ecosystem, even as leading AI assistants are knocking on the door, is a lot for Google to overcome. The DOJ\u2019s proposed remedy\u2014Alphabet divesting itself of the Chrome browser\u2014comes as rivals like Perplexity, OpenAI, and Anthropic are developing assistants that can integrate with other Android apps. The pressure on Google to open its ecosystem is mounting, and the competition is already finding their way in.<\/p>\n Primarily, it\u2019s the loss of Google Search being the default search engine on Samsung devices that poses a larger threat to the company, in our opinion. This is because any loss of real estate \u2013 especially on mobile \u2013 during a time when there are fierce rivals only creates more headwinds for the stock.<\/p>\n