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Google Fiber Has ‘Good Shot’ at Profitability: Analysts

Motivation is to Create Profitable, Standalone Business Capable of Achieving High Penetration Rates, Finds Bernstein Research 5/28/2013 6:07 AM Eastern

It’s “quite plausible” that Google Fiber’s deployment in the Kansas Cities will deliver an attractive internal rate of return (IRR) based on anticipated costs and expected demand for services, while also representing a scenario that could be replicated in other markets,  Sanford C. Bernstein concluded in a report issued Tuesday.

Google Fiber has “a good shot at being profitable” while also doing some damage to incumbent service providers over the long haul, noted report authors Carlos Kirjner and Ram Parameswaran.  

Bernstein foresees probability occurring in two different scenarios – one in which Google Fiber is able to crank out highly attractive IRRs of greater than 35%, as well as an “overly pessimistic” view that generates an IRR of just 12% -- still slightly above Google’s cost of capital.

The level of success will be determined in part by how differentiated Google Fiber’s services are, if Google Fiber can sustain high service penetrations, and if it can scale economically without compromising service quality, the report said. Among other key factors: the penetration of homes passed when Google first starts to deploy the network, and the service penetrations achieved during the first five years.

Bernstein has already taken a look at anticipated demand. Earlier this month, its door-to-door survey of 204 residents found that 52% said they would “definitely or probably” buy Google Fiber, while another 25% said they may purchase the service. Only 19% said they definitely or probably would not buy service from Google Fiber. 

“We think Google is seeking to differentiate its offer in ways that make it at least plausible that it will reach penetrations well in excess of 30% of homes passed,” Bernstein said. Its "base case" assumes a penetration of 33% percent, but sees rates in the range of 40% to 50% as likewise achievable.

The research firm also doesn’t buy into opinions that Google Fiber’s primary intent is to nudge other ISPs into accelerating their pursuit of 1 Gbps speeds or to influence regulators. “We believe Google’s primary motivation to deploy Google Fiber is to create a profitable, ‘standalone,’ new business, providing high-speed Internet access and pay-TV to consumers and small medium businesses,” it said in the report.  

In an earlier report, Bernstein estimated that Google will spend $84 million to pass (not connect) the 149,000 homes targeted for the first phase of the deployment in the Kansas Cities. It further estimated that Google would have to spend $11 billion to pass 20 million homes – about 15 percent of all U.S. homes -- with its fiber network over a period of five years.

Still, the Wall Street firm said Tuesday that it is be “unwise to extrapolate from the failure of previous overbuilders” or the limited success of Verizon FiOS to conclude that Google Fiber can’t succeed, noting that Google has some unique assets and capabilities, including datacenters, a “uniquely strong brand” and lots of cash.

“In other words, the tempting intellectual short cut ‘Verizon could not do it, so Google won't be able to do it,’ is not just lazy, it is fallacious. We believe Google Fiber has to be re-evaluated anew,” Bernstein said in the report.  

In addition to the Kansas Cities, Google Fiber has also received approval to build in Grandview and Raytown, Mo.; and in Shawnee and Olathe, Kan. It also has plans underway to start connecting homes in Austin, Texas, by mid-2014, and has a deal on the table to take over the iProvo fiber network in Provo, Utah. Depending on the market, Google Fiber is poised to face off with a variety of incumbents, including Time Warner Cable, AT&T, Comcast, CenturyLink and SureWest Communications.

And expect more ISPs to join that list. “We have high conviction Google Fiber will continue to add new markets over the next 12-18 months,” Bernstein said.

But how far and how wide Google Fiber will go and how successful it will become is a topic of much debate. Last week, IHS Screen Digest issued a report concluding that Google Fiber "is set to remain a minor player in the U.S. broadband market, with the company unlikely to deploy the service nationwide due to its high costs," noting that Google Fiber's current target markets represent only about 0.4% of U.S. households.

Bernstein agreed that Google Fiber will have a “limited” short-to-medium term impact on the economics of incumbent providers, and that its focus on limited markets will keep ISPs from responding with a "scorched earth approach." But its analysis likewise "suggests that long-term investors in cable and telephone companies should at least seriously consider the possibility of ‘the frog slowly being boiled.'"

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April