The following commentary was originally sent to Action Alerts PLUS subscribers on Feb. 4, 2016, at 5:30 p.m. ET.
Alphabet (GOOGL) reported spectacular results on Monday in the face of towering expectations. What mattered most to investors, however, was the company's new disclosure format, which broke out core Google (i.e., Search, YouTube, Gmail, Maps, etc.) and "Other Bets" (includes Nest, Fiber, Autonomous Driving, etc.). The company delivered on this front as well, as the newly split disclosure indicated that core Google has become more profitable over time (a crucial consideration for fundamental investors). (Alphabet is part of TheStreet's Action Alerts PLUS portfolio.)
While the Other Bets segment posted a loss of roughly $3.1 billion, this was actually on the low end of what analysts were expecting (anywhere between $3 billion and $5 billion). In fact, investors appear willing to give management leeway on their moonshot businesses since the strength of the core business has been confirmed.
Now that we've had a few days to contemplate the results, disclosures and commentary, we have increased appreciation for the "Other Bets" business; rather than viewing it as a drag to profitability, we think it is a crucial component of what makes the company so great: It is constantly investing in the future -- in many cases five to 10 years out -- a strategy we consider prudent as its core search business will inevitably begin to mature (though will always remain an incredible generator of free cash flow). For this reason, over the coming weeks we will be exploring the long-term potential across three of Google's largest "moonshot" projects: Fiber, Nest (home security) and Autonomous Driving. In this bulletin, we evaluate Fiber.
We think the Google Fiber project has the potential to be a major disruptive force in the pay-TV market, otherwise categorized by the acronym MVPDs (multichannel video programming distributors), the likes of which include Time Warner/Charter (TWC), Comcast (CMCSA), AT&T/DirecTV (T), as well as Verizon Fios (VZ). This is not an immediate threat, as Google seems to be building out Fiber in selective pockets, but assuming the company continues to accelerate its investments in the space, broadband growth rates for legacy MVPD providers could come under pressure.
So what is Google Fiber and what makes it so potentially disruptive? Fiber is a broadband Internet and TV service boasting download speeds of one gigabit per second at a fractional cost vs. the competition; before Fiber ever came onto the market, the average U.S. broadband network had speeds that were one-hundredth that of Fiber. In fact, Fiber's launch announcement in July 2012 turned the entire telecommunication and broadband service complex on its head, sending companies across both sectors on a rush to upgrade their speeds and/or slash prices.
On Monday's conference call, we learned that Google has spent $1.4 billion over the past two years on capex in "Other Bets," the bulk of which was on Google Fiber. Management also mentioned that they intend to ramp up this spending, especially as they build out in six upcoming cities and 11 potential cities. So while the near-term impact on both the industry and Google's results are limited at best, the longer-term potential is significant, as over 100 million residential homes in America rely on broadband, along with tens of millions of commercial enterprises.
The costs are significant as well, but Google could potentially build upon existing infrastructure to leverage a cost-efficient and value-additive platform in the long term. It remains to be seen how large of a business Fiber could be, but the optics are intriguing at first glance.