Americans everywhere rejoiced earlier this week when news came that Google is planning to launch a cable-company-killing TV-and-Internet service in Kansas City later this year.
If ever there was a consumer market in need of disruption it is the local TV-distribution market, in which cable companies generally have a monopoly position and monopoly attitude.
(Yes, satellite and telco TV have chipped away at the monopoly, as has the Internet. But the cable companies still have enormous power and profits, and that power is reflected in their monthly bills.)
So the idea that Google may come charging into markets, build new fibre networks, and provide a super-high-speed Internet-based alternative to cable companies is great news for consumers.
But it’s lousy news for Google investors.
Because building and operating local fibre networks is seriously expensive.
One of the remarkable aspects of Google’s core business is how much cash it generates.
In 2011, Google’s business generated $15 billion of cash flow from operations. To support this cash flow, Google also invested about $4 billion in property, plant, and equipment (buildings, servers, data centres, etc.). This left the company with about $11 billion of free cash flow–cash that piled up on its balance sheet.
In other words, for every dollar of cash Google generated from its business operations, it kept about 75 cents after capital investments.
This compares very favourably to the economics of a cable or telephone company, which has to spend much more money on equipment.
Take Verizon and Comcast, for instance.
In 2010, Verizon generated a staggering $33 billion of cash from operations, more than twice as much as Google generated. But Verizon had to spend a whopping $16 billion on equipment. This left it with only $17 billion of free cash flow.
Verizon, in other words, only keeps about 50 cents of cash for every dollar of cash its operations produce.
Comcast, meanwhile, generated $11 billion of cash from operations in 2010 and spent $5 billion on equipment. This left it with free cash flow of $6 billion for the year, about 55 cents on the dollar.
Ultimately, what investors are buying when they buy stocks is a claim on the free cash flow of a company–the cash left over after all the bills are paid.
This is one of several reasons why Google trades at a higher multiple of operating cash flow than Comcast and Verizon do. (The other reason is that the market concludes, probably rightly, that Google’s future growth prospects are better).
If Google plunges headlong into the the local-fibre-and-Internet service market, it will have to spend a much higher percentage of its cash-flow from operations on equipment than it currently spends.
Google will still have its core search business, of course, so its cash-flow conversion won’t get as bad as that of Verizon and Comcast. But it will deteriorate.
And, all else being equal, that will cause Google’s stock multiple to compress.
Of course, Google’s foray into the local fibre business also highlights another concern that investors have about Google–namely, focus. Despite CEO Larry Page’s new focus on focus–Page has killed a lot of pet projects Google was playing with–Google is still trying to fight an alarming number of wars:
- The search war against Microsoft
- The gadget and mobile operating system war against Apple (Google just bought Motorola, don’t forget)
- The business application war against Microsoft (an area in which Google is drastically underperforming its potential)
- The social war against Facebook
- Self-driving cars, computerized glasses, wind power, and other cool love projects against whoever is competing in those businesses, and now
- The TV and Internet access war against cable companies and phone companies
Is Google going to win all those wars?
Does Google have the discipline to focus on winning a few critical wars instead of a half-dozen that it might want to win but can’t?
Remains to be seen.
But make no mistake: The penalty for trying to fight ALL wars instead of picking the couple that are critically important to your future is big.
15 years ago, a company called Microsoft that was trying to do everything was dragged into court and threatened with breakup because its monopoly power seemed so acute that it was stifling competition in the tech industry.
Microsoft’s value has decreased since then.
The value of Apple and Google and IBM, meanwhile–companies that, initially anyway, focused intently on winning only one or two wars–has skyrocketed.
Google would do well to remember this.
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