Alphabet and Microsoft put AI spending under the microscope

Initial share price reactions to third quarter earnings from Alphabet and Microsoft could not have been more different with the former sinking around 11%, wiping out around $400 billion of market value, while Microsoft shares were up around 4%.

A simple explanation is that Microsoft’s headline numbers came in ahead of analysts’ forecasts while Alphabet fell short, but there is a more nuanced interpretation.

Both companies showed that demand continues to outstrip supply for AI cloud services with Microsoft’s Azure revenue up 48% and Google’s cloud revenue up 103%. The ability to finance computing capacity is becoming the key question for investors.

Cost of financing the AI arms race comes into focus

Microsoft and Alphabet continue to spend heavily to build out AI infrastructure, but the key difference is that Microsoft remained cash flow positive in the quarter while Alphabet saw an increase in negative free cash flow.

With the caveat that Alphabet’s operating cash flow was also impacted by an inventory build-up for its custom AI chips, the company ended the quarter with $125 billion of long-term debt compared with $21.6 billion a year ago.

By contrast, Microsoft remains in a net cash position and has been able to finance capital expenditures from internally generated cash flows. Alphabet is increasingly raising new equity as well as debt to stay in the AI capital expenditure arms race.

What are Microsoft and Alphabet projecting to spend in 2027?

After increasing capital expenditures by a around a third to $45.2 billion in the quarter, Microsoft’s chief financial officer Amy Hood projected capital expenditures of more than $50 billion in the current quarter and is aiming to spend $170 billion in fiscal 2027.

Alphabet reiterated full year capital expenditures of between $195 billion and $205 billion with chief financial officer Anat Ashkenazi saying spending would increase ‘significantly’ in 2027.

With investors increasingly questioning whether the huge spending on AI will earn an adequate return, the focus on cash generation and balance sheet strength is becoming a key differentiator.

Further evidence of this scrutiny and shareholder preference is evident in Oracle shares jumping 10% on 27 October after saying it expects free cash flow to turn positive in the second half of fiscal 2028 and top $30 billion in fiscal 2029, when capital spending is set to decline.

Changing narratives

In the early days of the AI revolution, Alphabet was seen as a potential victim due to AI’s threat to Google’s search engine which is a key driver of advertising revenue.

The success of Alphabet’s large language model Gemini and integration into its suite of products in late 2025 seemed to change that narrative with investors seeing Alphabet as a potential AI winner.

In the last quarter Alphabet said its Gemini app has reached one billion users, making it the fastest-growing product in Alphabet’s history, giving Gemini serious scale.

However, investors were spooked by signs that Google might be struggling to monetise AI as advertising revenue growth lagged in search which recorded the highest query growth rate over the last five years.

Microsoft rises from the ashes

Microsoft came under scrutiny in early 2026 after Anthropic released a suite of AI software tools which threatened Microsoft’s key enterprise business.

The shares fell by more than a third before recovering to scale new all-time highs in October, reflecting increasing optimism over Microsoft’s ability to monetise AI.

Microsoft said adoption of Copilot increased nearly 50% quarter-on-quarter, while the number of customers with more than 50,000 licenses increased more than eightfold.

While this shows increasing evidence that AI is generating revenues, the bigger question of whether that revenue will ultimately generate an adequate return remains a key question.