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Alphabet Shares Fall After Cloud Unit Misses Estimates

(Bloomberg) — Alphabet Inc.’s cloud computing unit reported a smaller than expected profit, raising concerns about the company’s position in a market that is critical to its future. Shares of Alphabet fell 6.5% in premarket trading on Wednesday.

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As Google’s dominant search business matures, investors are looking to the cloud unit to take the lead on growth. The unit reported operating income of $266 million, missing estimates of $434 million.

Google has long trailed Amazon.com Inc. and Microsoft Corp. in the market for cloud computing, in which companies sell space on their servers and software to enterprise clients. Google Cloud, which reported a profit for the first time earlier this year, has been attracting business from artificial intelligence startups. But its momentum fell short of expectations in the most recent quarter, prompting some concern that the gap between Google and its rivals is widening.

“Cloud computing is a much lumpier business than advertising, and one where Google is facing stiff competition,” said Max Willens, an analyst with Insider Intelligence. “While the traction it has among AI startups may bear fruit in the long run, it is not currently helping Google Cloud enough to satisfy investors.”

The company’s shares dropped to $129.80 in early trading before New York exchanges opened on Wednesday, after previously closing at $138.81. The shares have gained 57% so far this year.

Alphabet President Ruth Porat said in a press interview that the unit’s sales had been affected by some customers’ cost-cutting. Porat is still acting as the company’s chief financial officer while Alphabet searches for her replacement following her promotion.

Read More: Microsoft Sales Top Estimates as Cloud Growth Picks Up Steam

The results marred an otherwise healthy report. Third-quarter sales, excluding partner payouts, were $64 billion, Alphabet said in a filing Tuesday. Analysts had predicted $63 billion, according to data compiled by Bloomberg. Net income was $1.55 per share, compared with Wall Street’s $1.45-per-share estimate.

The company posted $44 billion in search advertising, beating the average analyst projection for $43.2 billion.

The company was pleased with its advertising revenue growth after a period of “historic volatility,” Porat said on an investor call after the results.

The market for search — which Google dominates — is facing new threats from the rise of generative AI chatbots. Those are programs that answer users’ questions in a more conversational fashion when given a prompt. Companies including Microsoft, which backs Open AI Inc.’s ChatGPT, are challenging Google’s search lead with the new technology.

The company has raced to weave generative AI technology into its own products, but some in Silicon Valley say the tech giant has been too slow to detect the shift in the market, creating an opening for its rivals.

Porat and Alphabet Chief Executive Officer Sundar Pichai said that they would continue to find ways to operate more efficiently, with Porat noting that the company would maintain a “slower pace of headcount growth.” The goal of those efforts is to free up as much room as possible to invest in opportunities such as artificial intelligence.

“We’ll do everything that is needed to make sure we have the leading AI models and infrastructure in the world, bar none,” Pichai told investors on a call.

Google’s ongoing trial with the US Department of Justice over the alleged abuse of its search market power is also weighing on Wall Street’s enthusiasm, said Evelyn Mitchell-Wolf, a senior analyst with Insider Intelligence. “Any outcome should influence investor confidence in the longevity of the Google business model.”

YouTube reported $8 billion in revenue, compared with analysts’ average estimate of $7.8 billion. The unit has been a drag on Alphabet’s performance in recent quarters, but the results indicated that it is benefiting from the broader recovery in digital advertising spending.

Alphabet’s Other Bets — the company’s moonshot unit that includes the self-driving car effort Waymo and the life sciences unit Verily — brought in $297 million in revenue while losing $1.2 billion, in line with analysts’ projections.

(Updates with premarket trading from first paragraph)

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