Nomura: Alphabet’s cloud revenue doubles as AI investment lifts growth and weighs on cash flow

Why did overall results miss expectations despite cloud strength?

In the third quarter of 2026, Alphabet reported revenue of 127.577 billion dollars, up 24.7% year over year but 0.2% below Bloomberg’s market consensus. Net income was 26.17 billion dollars, down 25.2% year over year and 28.5% below consensus.
The decline in net income was mainly due to unrealized net losses on equity securities. Meanwhile, the overall operating margin was 31.8%, below market expectations of 33.7%, indicating that profit pressure was not confined to net income.

Google Cloud’s third-quarter revenue reached 30.7 billion dollars, up 102.6% year over year and 24.0% quarter over quarter, and 6% above market consensus. Its operating margin rose 0.6 percentage points quarter over quarter to 36.2%. The company attributed the growth to strong demand for enterprise AI infrastructure and solutions.
The cloud contract backlog rose from 514 billion dollars in the second quarter to 561 billion dollars, most of it regular Google Cloud Platform contracts. Management expects more than 55% of the total backlog to be recognized as revenue over the next 24 months.
AI usage is also expanding: Google’s proprietary model APIs process nearly 32 billion tokens per minute, more than 4 times the level a year earlier; the Gemini app reached 1 billion users.

Alphabet’s third-quarter capital expenditure was 51.4 billion dollars, up 114.4% year over year and 14.3% quarter over quarter, but still about 8% below market consensus. Management said most investment went to AI technical infrastructure, with about 65% allocated to servers and networking equipment and about 35% to data centers.
Heavy investment reduced third-quarter free cash flow to negative 9.1 billion dollars. The company maintained its full-year 2026 capital expenditure guidance of 195 billion to 205 billion dollars and expects a significant increase in 2027.
Computing capacity remains in short supply. The company began using third-party computing resources at the end of the third quarter and expects to expand their use in the fourth quarter; this will put pressure on near-term cloud margins.

Compared with the previous TPU generation, TPU 8T delivers up to 2.7 times the training performance, while TPU 8I improves inference price-performance by 80%. Google is expanding TPU distribution beyond its own cloud, including to customer data centers and through partnerships with Oracle and CoreWeave, among others.
Google Cloud expects TPU system sales to continue expanding in the fourth quarter of 2026 and generate significant revenue growth in 2027.
Nomura believes Google’s continued infrastructure spending and technology upgrades benefit optical module and PCB suppliers, including Innolight, WUS PCB and Victory Giant. The extent of the benefit remains dependent on demand for the relevant products and the pace of upgrades; Nomura also identified risks including demand for high-end optical modules, PCB competition and a slowdown in technology upgrades.