Google revenue is up 25%. Cloud revenue is up 103%, is what I have here. The stock immediately tanks. Maybe 'tank' is a strong word. What are investors reacting to?
That's more than $300 billion of market cap, so that's tanking. Yes, it's that core advertising business. We have long been worried that that business would be negatively impacted by AI. And it is Google Search that was the big weakness. If people stop Googling and start GPTing, that means less ad sales.
Welcome to Prof G Markets. I'm Edson. It is October 29th. Let's check in on yesterday's market vitals. The major indices climbed following the Federal Reserve's interest rate decision. More on that in a bit. The yield on 10-year Treasuries rose. Brent crude remained elevated around $114 per barrel on news that the US may strike Iran again after the midterms. And finally, Oracle shares popped 11% after the company projected a return to positive free cash flow in 2029. Okay, what else is happening?
Microsoft and Google both reported earnings yesterday, but investors had very different reactions to the results. Microsoft beat expectations with revenue up 19% year-over-year. The company also disclosed Azure revenue in its earnings statement for the first time, revealing that its cloud business grew 48% from a year earlier. Shares jumped as much as 5% in after-hours trading. Google's earnings, meanwhile, disappointed investors despite posting 25% revenue growth in the third quarter. Advertising revenue fell short of analyst expectations, and the company reported a decline in free cash flow. Shares dropped as much as 11% following that report. Here to break it down, we're speaking with Gil Luria, head of technology research at D.A. Davidson. Gil, thank you for joining us. I'm more interested in Google, but let's start with Microsoft and then we'll get to Google. What stood out to you?
That it was a clean beat across the board. So, not only was the Azure business great, it accelerated from 43% to 48%. This is a $120 billion-plus business. Those are tremendous growth rates at better margins. But also the rest of the business, the non-AI business, performed well enough that that translated to overall revenue beats, earnings beats, better guidance than expected — a clean beat and raise, which is why the stock is up. And importantly, it's a company that still has positive cash flow. Can't say that about Amazon, Google, and Meta. It is true about Microsoft, and right now that's what investors want to hear.
That's what I was going to bring up, which is that their free cash flow is still positive. Cannot say the same about Amazon or Google or Meta. That statement in and of itself is quite striking. But it came down significantly, down 27%. Basically, they're spending ridiculous amounts on data centers, but not so ridiculous that their cash flow is negative. I guess talk more about their spending plans here when it comes to AI.
So what Microsoft does slightly different — so different than Amazon and slightly different than Google — is they've been relying on overflow capacity from NeoClouds. So they don't need to build all the data center capacity to meet their customer needs. They just need to build enough that they have good visibility. So, they're making 15-year commitments on a significant portion of their buildout, but then they're saying, you know, that doesn't meet demand right now. Let's go get some of the compute elsewhere on short-term contracts with these NeoClouds, so that we can still provide what our customers want, but we don't have to spend as much on capex. Not to mention the fact that they just have a more profitable business. So, the combination of those two things means they can stay free cash flow positive.
The reason that's important is that that means they don't have to go to the capital markets, right? We saw Google with a debt raise and an equity raise. They're still issuing stock in an added market offering. We saw Meta sell stock, and they're going to have to borrow, and they're doing special purpose vehicles. Microsoft doesn't have to engage in that. They have positive cash flow, even if it is lower, so they don't have to raise capital again. That makes them look better. They're all spending a lot, but Microsoft's doing it a little bit more responsibly, and sometimes that's all you need to get the credit from investors.
You say it makes them look better. Do you believe that it is better, that it puts them in a genuinely stronger position? Because that seems to be, to me, that seems to be the big question and the most important question, which is like, where's the money going to come from? And if you have to raise it from someone else, which is what we're seeing with Meta — and I'm looking at Meta getting crushed this week — that's kind of a problem, especially if the money, for whatever reason, dries up. I don't think it will in the case of big tech, but we have seen a lot more pressure on some of those smaller names like the NeoClouds. It seems like Microsoft is in a genuinely stronger position than the rest of the hyperscalers.
Yes, absolutely. And part of it is that they have a much more thoughtful approach. Again, they're taking some longer-term investment, some shorter-term capacity. They're lending themselves to what they have. Again, they're still expanding their business. 48% growth in Azure — that's still accelerating on a $120 billion business — is still tremendous growth. It's drawing other revenue. That's important because Microsoft, on top of the AI compute, is also selling a lot more enterprise software, a lot more infrastructure software, a lot more application software, bumping up the tiers for companies that use Windows and Office products. They're leveraging AI to do that.
So they can have the resources and they can just draw the limit to say, you know, let's not spend more than what we have. We're generating a lot of cash flow. This is a good return. It's helping the rest of our business. But if we don't spend more than we have, we don't have to borrow. We don't have to be beholden to the capital markets, which we've now seen what the capital markets are doing to Meta. Microsoft doesn't have to engage in that.
Okay, let's shift to Google. So, Google revenue is up 25%. Cloud revenue is up 103%, is what I have here. The stock immediately tanks. Maybe 'tank' is a strong word. It's down 9% in after-hours. What are investors reacting to?
Well, that's more than $300 billion of market cap, so that's tanking. Yes. It's not the cloud business. The cloud business is doing great. To your point, doubling — and again, doubling to $120 billion. There's a lot. Part of it is TPU sales now. A lot of it is the momentum in Anthropic. Talked about Anthropic decelerating, but still added a lot of revenue, and a lot of that goes in referral fees and compute fees to Google Cloud. So that part of the business was great. If that's all they reported, the stock would be up. It's the other part. It's that core advertising business. We have long been worried that that business would be negatively impacted by AI. And it is Google Search that was the big weakness. If people stop Googling and start GPTing, that means less ad sales.
And they've been able to assuage those concerns for the last couple of years and keep nice growth rates within Google Search, but this quarter it appeared to abruptly slow down. They're talking about having tough comps, but that's an abrupt slowdown that nobody expected. And so now investors are going to ask themselves, is it happening? Does the shift to AI now mean that the most lucrative business Google has ever been in — which is selling search ads — is that business going to be impacted? That's why you're seeing that big step down in the stock, is that that's the core cash generator. If that's suffering — and by the way, it's not the ad market that's the problem — Meta accelerated growth to the high 20s last week. Meta is now growing more than twice as fast in the digital advertising business than Google. They're gaining a lot of share. The concern seems to be specifically about what Google is doing in search advertising.
Do you believe that that is what is happening? Do you believe that? And to be clear, it's not that the search revenue is falling, but the growth is slowing down. And part of me thinks, well, this is a gigantic business to begin with. A slowdown in growth, I'm not necessarily that surprised by. But do you think that it is genuinely a reflection of people not using the product as much because they're using other products? They're using ChatGPT, they're using Claude, they're using all of these things that everyone was so afraid would eat Google's lunch at some point.
It's too early to tell, right? One quarter. I don't think investors need to panic about it. It's just this was the raw nerve that got exposed when ChatGPT came out. When ChatGPT came out, we all jumped to the conclusion that this is going to happen. It didn't happen for the subsequent three years. That's why we're very on edge about the possibility of this change in behavior impacting their advertising business. But you're right, they're still growing. It's one quarter. You don't need to panic. But it is something that is very much top of mind because, again, that's where a vast majority of the profit comes from for Google. That is the engine, that is where they had overwhelming share. Remember, we all used to Google — 90% plus share in the search market.
In the chat market, there are two: ChatGPT is the number one chat, and then it's Gemini. And now we also have a digital assistant category, which is very adjacent, and it took the lead there. This is the concern: is maybe it is happening. And Google's done a good job of selling a lot of ads in the AI flow, but maybe at some point that's not enough because they are losing in that behavior. People are changing their behavior, and maybe that's just accelerating right now.
What about the capex? It jumped again. It hit more than $51 billion in the quarter. It's up from $45 billion in the previous quarter. Free cash flow is negative again, but now we're at negative $9.1 billion. That jumped out to me. Is it significant in your view, the amount that they are technically losing on a cash flow basis to build these data centers?
Yes, because it means that they'll have to go back to the capital markets if they keep it this way. Let's not forget last quarter they told us, when they reported, they repeated that they're going to increase capex significantly next year. We're all taking that to mean that they're going from 200 to 300 billion. That's a lot of capital they're going to have to raise, and the capital is available to them. When we talk, this isn't core to Google, people will be willing to buy Google shares in the market, but still, that's pressure. It's pressure on the yield that they're going to have to pay. It's pressure on the share price. The more they use cash, the more they have to raise. That's going to be on investors' minds as well.
One of the interesting things that they said was, we are now starting to offload because we can't handle all the demand. So again, Microsoft started this strategy three years ago and is now much better positioned to manage its cash flow. Google now realizes that it has to do it as well, and is reacting by offloading capacity. That means lower margins, which again feeds into these concerns about the core business.
What do you make of these share sales, these equity issuances, these debt issuances? Because it seems like this AI trade is increasingly becoming — or these companies are becoming increasingly dependent on someone that isn't them, specifically the capital markets. And you know, that's okay so long as there is real demand in the capital markets, and it appears there is. We can look at Meta's share sale, where my understanding it was five times oversubscribed, and it worked. They wanted to go out and raise, I think, $85–95 billion, and they were able to do it. But at the same time, you're opening yourself up to this vulnerability, which is like, we're no longer self-sustainable on this path. We require help from you, from investors. We need you to fund us via issuing shares or via issuing debt. And I guess the logical next question as we enter this next chapter is, how long can that go on? Like, at what point could the music stop and investors say, we don't want to do this anymore? And when that happens, they're screwed, right? Is that too much to say that?
It depends on who you mean by 'they'. So yes, capital is finite. It hasn't seemed like it so far. A lot of capital's flown into building out the AI ecosystem, but it is finite. In fact, Meta pointed this out in their filing last week. They said, 'Hey, look, we need to go get capital before it's all gone.' Right? SpaceX raised a lot of capital. Anthropic's going to raise a lot of capital in three weeks. And now Google went out and got a lot of capital. Meta's going in. It's finite. There's only so much equity and, importantly, debt investors are willing to fund this buildout.
So at some point, not everybody's going to get a piece, and some parts of the capital markets may actually already be seizing up, right? That's what we saw with some of these higher CDSs and very high yields on some of these outstanding bonds, is that it is finite. Some parts of it may be seizing up, but Microsoft's going to be fine. They don't need capital. Amazon, Google, Meta — still investment grade, can probably raise as much as they want to a point. It's everybody else that you have to worry about.
Oracle talked about the fact that they've changed their plans, that they're now only going to raise $20 billion — $10 billion in equity and $10 billion of debt. That's not because they don't need a lot of capital. It's because they had to go to Plan B. Plan B is bring your own chip. Plan B is vendor financing. And because they are recognizing that the capital is not as available as it used to be. Once you start getting past them in the value chain, in the food chain, and you get the ankle-biters like CoreWeave, I'm not sure where the capital's going to come from.
