Alphabet Inc: Record Cloud Surge Offset by Search Slowdown — Target Price US$375 November 12, 2026
Brief Overview
Alphabet Inc delivered third-quarter 2026 earnings below Phillip Securities Research’s expectations. Revenue increased 25 per cent year on year to US$127.6 billion, driven by strong growth in the core advertising and Cloud segments, while adjusted profit after tax and minority (PATMI) interests grew 10 per cent year-on-year to US$33 billion. Nine-month revenue and PATMI reached 72 per cent and 63 per cent respectively of full-year 2026 forecasts, subject to the seasonality of the advertising business. Google Cloud Platform growth was robust, while Search revenue slowed. Free cash flow remained negative at US$9.1 billion due to heavy artificial intelligence investment.
Investment Positives
Record Cloud Growth
The standout development in the quarter was the record performance of the Cloud segment. Revenue surged 103 per cent year –on year to US$30.7 billion, the fastest growth recorded by the segment, compared with 34 per cent growth in the third quarter of 2025. This exceptional acceleration was driven by strong growth in Google Cloud Platform, particularly across infrastructure, platform services, and TPU system sales.
Enterprise adoption of Gemini Enterprise remained robust, with model API usage rising to more than four times last year’s level and enterprise spending quadrupling year on year. Cloud operating income tripled year-on-year to US$11.1 billion, with the operating margin expanding by 1,250 basis points to 36.2 per cent, demonstrating significant operating leverage as the segment scales.
Enterprise adoption of Gemini Enterprise remained robust, with model API usage rising to more than four times last year’s level and enterprise spending quadrupling year on year. Cloud operating income tripled year-on-year to US$11.1 billion, with the operating margin expanding by 1,250 basis points to 36.2 per cent, demonstrating significant operating leverage as the segment scales.
We increased the financial year 2026 Cloud revenue forecast by 9 per cent to reflect accelerating growth in the fourth quarter, driven by initial revenue contributions from TPU systems and the gradual conversion of the sizeable backlog. Wider enterprise adoption of AI solutions is also expected to support incremental demand for compute, database storage and cybersecurity services.
Investment Challenges
Negative Free Cash Flow Continued
Free cash flow was negative for the second consecutive quarter at negative US$9.1 billion, as third-quarter capital expenditure grew at its fastest pace since 2018 to support TPU system build-up. The US$51.4 billion capital expenditure was mostly directed towards servers and networking equipment, at 65 per cent of the total, with data centres accounting for the remaining 35 per cent. Free cash flow was further weighed down by a one-off US$5.2 billion cash payment relating to the European Commission fine issued in 2018, following the conclusion of the appeal process.
We forecast negative free cash flow of US$18 billion and US$32 billion in financial years 2026 and 2027 respectively. The elevated cash outflows reflect upfront investment in expanding compute capacity to fulfil secured customer commitments, creating a timing mismatch between cash outflows and revenue realisation rather than signalling weakening demand. With industry-wide compute capacity remaining constrained, sustained AI infrastructure demand is expected to support Google Cloud’s growth as additional capacity comes online and is monetised.
Slowing Advertising Growth
Advertising revenue growth moderated to 11 per cent year on year in the third quarter, reaching US$82 billion, compared with 13 per cent growth in the third quarter of 2025. Search revenue grew 12 per cent year on year to US$63.4 billion, down from 15 per cent in the prior year period, with management attributing the slower growth to lower monetisation of AI Mode despite search query growth reaching its highest level in five years. Strong user engagement was largely driven by AI-powered search, with queries being three times longer than traditional searches.
YouTube advertising revenue growth also moderated to 9 per cent year on year to US$11 billion, down from 15 per cent, as foreign exchange headwinds offset continued momentum in brands and living room viewing. Beyond lower monetisation of AI searches, advertising revenue also declined on a quarter-on-quarter basis, partly reflecting weaker spending from APAC advertisers following the removal of the EU de minimis exemption and the normalisation of advertising spend following the FIFA World Cup.
To capture monetisation opportunities from AI Mode, the company announced the expansion of advertisements into international markets and launched multi-turn advertisements in the United States. We reduced financial year 2026 and 2027 Search revenue forecasts by 1 per cent, now expecting the segment to grow 14 per cent and 11 per cent respectively. While the plan to expand advertisements on AI Mode is viewed positively as it could unlock additional monetisation by improving revenue per query, near-term margin headwinds are expected from higher compute costs associated with AI-powered Search compared to traditional Search. However, margins are expected to gradually recover as inference efficiency improves, with AI Mode response costs reaching the lowest level since launch in the second quarter of 2026. We also remain cautious about user retention, as users could increasingly shift towards competing AI search platforms and chatbots.
Outlook
The outlook is shaped by the tension between exceptional Cloud momentum and moderating advertising growth. Cloud revenue growth is expected to accelerate further in the fourth quarter, supported by TPU system contributions and backlog conversion, while wider enterprise AI adoption should drive incremental demand. However, Search and advertising face near-term headwinds from lower AI Mode monetisation and higher compute costs, though margins should gradually recover as inference efficiency improves. Free cash flow is expected to remain negative through financial year 2027 as the company continues to invest heavily in AI infrastructure, but we view this as a timing mismatch rather than a sign of weakening demand.
Recommendation and Target Price
Phillip Securities Research maintains its BUY recommendation on Alphabet Inc but has lowered the DCF-based target price to US$375, from the previous US$425. Financial year 2026 and 2027 PATMI estimates have been reduced by 10 per cent and 11 per cent respectively to reflect higher costs. The lower target price reflects the earnings revision, while the maintained BUY rating reflects confidence in the long-term AI growth trajectory and the substantial Cloud backlog providing revenue visibility.
Frequently Asked Questions
Q: What is Phillip Securities Research's recommendation and target price for Alphabet?
A: The recommendation is BUY with a reduced DCF-based target price of US$375, lowered from US$425.
Q: How fast did Google Cloud grow in the third quarter of 2026?
A: Google Cloud revenue surged 103 per cent year on year to US$30.7 billion, the fastest growth the segment has recorded, compared with 34 per cent growth in the third quarter of 2025.
Q: What is the size of Google Cloud's backlog?
A: The Cloud backlog reached US$561 billion, up 9 per cent sequentially from US$514 billion, with approximately 55 per cent expected to be recognised as revenue over the next 24 months.
Q: Why is Alphabet's free cash flow negative?
A: Free cash flow was negative US$9.1 billion for the second consecutive quarter, driven by US$51.4 billion in capital expenditure to support TPU system build-up and a one-off US$5.2 billion European Commission fine payment.
Q: What happened to advertising revenue growth?
A: Advertising revenue growth moderated to 11 per cent year on year to US$82 billion. Search revenue growth slowed to 12 per cent from 15 per cent due to lower monetisation of AI Mode, while YouTube advertising growth moderated to 9 per cent from 15 per cent.
Q: How has Phillip Securities Research revised earnings forecasts?
A: Financial year 2026 and 2027 PATMI estimates have been reduced by 10 per cent and 11 per cent respectively, while financial year 2026 Cloud revenue forecasts were increased by 9 per cent.
Q: What is the outlook for free cash flow?
A: We forecast negative free cash flow of US$18 billion in financial year 2026 and US$32 billion in financial year 2027, reflecting upfront AI infrastructure investment to fulfil secured customer commitments.
Q: What steps is Alphabet taking to improve advertising monetisation?
A: The company announced the expansion of advertisements into international markets on AI Mode and launched multi-turn advertisements in the United States to capture monetisation opportunities from AI-powered search.
This article has been auto-generated using PhillipGPT. It is based on a report by a Phillip Securities Research analyst.
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About the author
Serena Lim Yi Qi
Serena is a Research Analyst covering the U.S. Technology sector at PSR. Prior to joining the firm, she worked as an Equity Dealer and held various roles across the insurance and banking industries. Serena holds a Bachelor's degree in Economics and a Postgraduate Diploma in Applied Finance from the University of Adelaide.
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