Alphabet Inc (GOOG) (GOOGL) exhibited brilliant foresight when it separate the current Google from the “future” Google. Stronger earnings and more transparency into its smaller ventures have pushed Google stock neck and neck with Apple (AAPL) for bragging rights to the world’s most valuable company.
But here’s what makes Alphabet so great: It’s always investing in the next five to 10 years. Rightfully so, since many of its core businesses are starting to mature.
One of Alphabet’s most hyped up-and-coming businesses is Google Fiber, and during the fourth quarter, investors were given their first real glimpse into the performance of this business, and it is not all that good.
What Is Google Fiber?
Alphabet may be on a high horse right now, but rest assured the day will come when paid clicks peak and core businesses like Google Search, YouTube, Gmail, Maps and even Android mature.
Which is exactly why Alphabet is investing in “Other Bets,” a unit comprised of mostly non-revenue earning businesses, but are promising nonetheless. Among them — Google Fiber.
Google Fiber is a broadband Internet and TV service boasting download speeds of one gigabit per second. Up until Google Fiber’s launch a couple years back, the average broadband network across the U.S. was 100 times slower. Nowadays, Google has sparked a movement where telcos and broadband service providers alike are rushing to upgrade speeds and/or slash prices.
Google Fiber essentially harbors the fastest speeds and the cheapest prices, a major disruption to the U.S. broadband industry.
Google Fiber at a Glance
The prospects for Google Fiber look amazing, with Goldman Sachs (GS) estimating upward of 100 million residential broadband homes in America, not counting the millions of business establishments that also require broadband Internet services.
Leading the market currently are Comcast (CMCSA), AT&T (T) and Verizon (VZ) … but the market is very fragmented. Google Fiber hopes to change that. If it can realize a 20% market share, it could easily produce $30 billion in annual revenue for Google, thereby creating a true catalyst to move Google stock even higher.
The problem is that Fiber is also very expensive, requiring a lot of capital to lay fiber optic cables.
GS estimates costs of around $120 billion for Google to become a nationwide service provider. And while Google has cut down many of these costs by building to demand and piggybacking the existing infrastructure of competitors, Fiber is likely still costing the company billions.
That said, Alphabet’s fourth quarter gave investors their first real look at Fiber as a business: Alphabet’s Other Bets segment grew 42% to create Q4 revenue of $151 million.
For the full-year, it grew 37% to $448 million. While encouraging, the operating costs for this segment were a whopping $1.1 billion and $3.57 billion, respectively, for Q4 and full year.
With none of Google’s moonshot businesses creating legitimate revenue or being capital intensive projects, investors can assume that the majority of this revenue and cost is driven by Google Fiber.
So What Does This Mean?
What’s very interesting is what Alphabet is having to sacrifice for growth. Clearly, revenue growth accelerated in the fourth quarter from 37% in the full-year to 42%, in its Other Bets segment.
This fact has been celebrated by many analysts. However, Alphabet’s $3.57 billion in annual operating costs imply an average cost of $890 million quarterly, illustrating how much Google had to boost spending to achieve that additional growth in Q4. Neither bode well for Alphabet or Google stock as the company plans to accelerate the rollout of Fiber in 2016.
I explained back in November why AT&T’s (T) GigaPower would eventually reign superior over Fiber, capturing the most market share and dominating the high-speed broadband space over the next decade. Why? Because AT&T has the infrastructure to make minimal investments to increase broadband speeds. Plus it already has a large existing network, which gives it a huge headstart.
One more thing: Alphabet is teetering back and forth on the brink of world’s most valuable company, and with it trading at a rather lofty valuation of 18.5 times forward earnings, about 100% more expensive than Apple, things like cost control and margins will be heavily scrutinized.
So look, while I see potential in Fiber, it could actually hurt Google stock in the short term … possibly even long term if GigaPower ends up being the dominant force that I expect.
The bottom line is that Alphabet’s fourth quarter proved how much it must spend to make Google Fiber relevant.
Given that its core businesses are still growing at a healthy clip, along with the fact that competitors like CMCSA and T will build the high speed broadband network that Google desires, I conclude that Alphabet should slow its Fiber initiatives and re-evaluate its prospects.
Unfortunately, that is not going to happen. For that reason, I would not go long Google stock.
As of this writing, Brian Nichols was long T stock and AAPL.
