Alphabet raises its capex forecast to $205 billion as Google Cloud surges by 82%.

      Alphabet entered its second-quarter results on Wednesday with one prominent question: whether the tens of billions invested in AI infrastructure have begun to yield returns. Based on the after-hours share price, the answer appears to be no, at least for now.

      The company reported a revenue of $119.8 billion for the quarter ending in June, which is a 24% increase from $96.4 billion in the same quarter last year and significantly above expectations.

      Google Cloud was the standout performer, with revenues skyrocketing 82% to $24.8 billion, operating income more than tripling to $8.8 billion, and its margin expanding to approximately 36%. The overall operating margin for the group increased to 34% from 32%.

      This trend keeps Alphabet in close competition with Nvidia as the world’s most valuable company, contributing to a Big Tech capital expenditure cycle that has now surpassed $650 billion annually. The cloud backlog, which includes contracted work that Google has not yet recognized as revenue, rose to $514 billion from $490 billion.

      Leading up to this quarter, there was considerable pressure. Bloomberg presented this quarter as a definitive test of whether the investments are paying off, and Alphabet was not alone in facing such scrutiny, as investors were pondering the same question with Tesla and other members of the Magnificent Seven that week.

      Investors were particularly unsettled by the spending rather than the growth. Alphabet raised its full-year capital expenditure outlook to as high as $205 billion, up from a previous range of $180 billion to $190 billion, and noted that quarterly capital expenditures nearly doubled from a year ago to $44.9 billion.

      Even $205 billion won't be sufficient. Alphabet indicated that it will continue expanding third-party capacity as a temporary solution while its own data centers are being developed, underscoring how rapidly demand is outpacing its construction capabilities.

      This spending led to a free cash flow of negative $5.9 billion, marking the first quarterly cash outflow in almost twenty years. Shares dropped about 5% in after-hours trading despite the revenue exceeding expectations, reflecting a recurring theme this earnings season where strong earnings get overshadowed by higher-than-anticipated capital expenses.

      The scale of the situation is significant. Alphabet is on track to invest more in capital expenditures in one year than it reports in net income during a similar timeframe, funding its investments primarily from a search and advertising business that is growing at a slower pace. Analysts have begun questioning when this gap will close.

      Supporters of the company point to the backlog as a strong argument. With $514 billion in contracted but not yet recognized revenue, it implies that the capacity being built has prospective buyers lined up. However, the more cautious interpretation is that this represents a commitment that Alphabet still needs to fund and fulfill as costs accrue.

      Both sides agree that the outcome hinges on the cloud becoming financially self-sufficient before the wave of capital expenditures peaks.

      The net income figure did not resolve the debate. While net income reached $112.1 billion, nearly quadrupling from the previous year, about $98 billion of this was attributed to an unrealized gain from Alphabet’s stake in SpaceX. Excluding this, the underlying profit appears much more typical.

      The core advertising business remained robust. Search revenue increased by 17% to $63.3 billion, and YouTube advertising grew by 13% to $11.1 billion. Additionally, the Gemini app reached 950 million monthly active users, and Alphabet's first-party model APIs processed approximately 22 billion tokens every minute.

      Sundar Pichai stated that AI features in Search are generating additional queries while still driving billions of clicks to websites weekly, and that AI Mode has exceeded 1 billion monthly users.

      To finance its expansion, Alphabet has already tapped a record $85 billion in equity and initiated a debut yen bond. CFO Anat Ashkenazi informed investors that no additional equity offerings are planned beyond a $40 billion at-the-market initiative starting this quarter.

      Despite the buzz surrounding the results, they leave unresolved the key question they were intended to answer. While it is evident that AI spending is fostering growth, when it will become self-sustaining and how much more Alphabet is willing to invest during the waiting period remains to be seen.