Key Takeaways
- Alphabet and Meta both burned cash in the third quarter as AI capex topped their operating cash flow, and Big Tech lost nearly $900 billion in market value last week.
- Depreciation from this year’s spending of about $500 billion will start to hit operating margins and earnings in 2027.
- Meta is already feeling it: depreciation rose 44% in the third quarter, and its operating margin before a legal charge fell about 5 points from a year earlier.
- Cloud growth gives Microsoft and Alphabet a real offset, which leaves Meta the most exposed of the three.
Big Tech lost nearly $900 billion in market value last week, after another jump in AI spending.
Alphabet (GOOG) fell 13% on Thursday after reporting negative free cash flow of $9.1 billion for the third quarter. The week before, Meta Platforms (META) spent $34.9 billion on capex against $32.8 billion of operating cash flow. Even Microsoft (MSFT) saw its free cash flow slip, to $18.6 billion in its September quarter from $25.7 billion a year earlier.
But Scale Venture Partners’ Rory O’Driscoll thinks the bigger hit is still to come. Here’s what he said on last week’s episode of 20VC:
“Frankly, earnings this year, 2026, are in that golden period where the people who are selling the semiconductors are booking the gains, but the people who are buying the capex aren’t booking the depreciation. So everybody’s winning. But I think if you start to look to 27, that depreciation is going to start hitting in Microsoft and Google and Meta and places like that.”
Together, the three expect to spend about $500 billion on capex this year. That cost reaches the income statement as depreciation, spread over the next several years.
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Alphabet is first in line
Alphabet kept its 2026 capex guidance at $195 billion to $205 billion. On the third-quarter call, CFO Anat Ashkenazi went further: “We continue to expect our capex to increase significantly in 2027, and will provide further details on our Q4 call.”
Analysts expect Alphabet’s normalized EPS to dip in 2027 and then jump 20% in 2028:
That $18.26 a share for 2028 has to cover the depreciation on a much bigger 2027 budget. I’d expect the estimate to come down once Alphabet puts a number on that budget.
The margins haven’t cracked yet
O’Driscoll also pointed out that operating income has kept rising so far, even as free cash flow went the wrong way. Meta’s operating margin has stayed above 40% for two straight years while it poured money into AI:
Microsoft’s operating margin hit a five-year high in the year to June 2026, even as its cash capex rose 79% to $115.9 billion:
But its depreciation and amortization also rose, to $38.5 billion in fiscal 2026 from $29.4 billion. Analysts expect $54.8 billion this fiscal year, a 42% jump.
Meta is already feeling it
Meta’s third quarter shows what’s coming. Depreciation and amortization rose 44% to $7.15 billion. Leave out a $9.89 billion legal charge, and costs grew 36% while revenue grew 26%. Without that charge, the operating margin was about 35%, down from 40% a year earlier.
Cloud growth is the best defense
Microsoft and Alphabet can rent their new capacity out to customers. Azure grew 48% in Microsoft’s September quarter, and Google Cloud revenue jumped 103% to $30.7 billion. Alphabet’s operating income rose 30% in the third quarter, at a 31.8% margin.
If cloud keeps growing like that, it can stay ahead of the depreciation for a while. Microsoft expects its fiscal 2027 operating margin to fall by less than a point.
Meta has no cloud business to rent out, so its payback has to come through ads. Its 26% revenue growth was excellent, and its costs still grew faster.
The bill gets paid in headcount
O’Driscoll expects the companies to find the money in their payrolls:
“And to keep the operating income up, you’re going to be really pushing on headcount. And this is when the bill for AI comes due, and this is how it’ll be paid.”
Microsoft is already doing it. Its operating expenses grew 7% in fiscal 2026 while revenue grew 18%, and headcount fell 2%. Last week, it offered buyouts to staff, and CNBC reported that about 60,000 employees are eligible, roughly 27% of its workforce.
The way I see it, 2027 is the year these margins come down. Meta has the least room to absorb that: it has no cloud to rent out, and its costs are already growing faster than its revenue. Microsoft looks best placed, with Azure’s growth and a margin guide that already includes the bigger depreciation bill.
Of course, cloud demand could stay ahead of supply long enough to cover the bill. The next test is Alphabet’s fourth-quarter call, where it has promised more detail on its 2027 spending.
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