Google Fiber Won’t Be A Capex Drain, Thinks Nomura

Google Fiber Won’t Be A Capex Drain, Thinks Nomura
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Nomura Global Markets Research analysts Anthony DiClemente and Ron Zember maintain a Buy rating for Google Inc (NASDAQ:GOOG) as they examine several concerns that have been on their radar screen.

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We want to address a concern we have recently been hearing from investors on the capex and opex implications of Google Fiber, which we believe would not be as detrimental to Google Inc (NASDAQ:GOOG)’s financials as they may seem to think. For some context, Google recently announced plans to expand its Google Fiber offering to 34 cities in 9 metro areas, and Google’s capex has been increasing rapidly.

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Benefits of Google Fiber

The main benefits of Google Fiber stem from its Gigabit internet speed – up to 100x faster than typical broadband connections. Such speeds ensure a seamless user experience for Google users; for example, no waiting for YouTube videos to cache, and Google Play movie download times shrink to minutes from hours. By offering faster speed, Google Inc (NASDAQ:GOOG) also puts pressure on competing carriers to jump-start their spending efforts on a faster internet.

There are two components of capex we associate with Google Fiber. The first is “passing” each home, or laying down fiber in front of potential customers’ homes, which we  estimate at ~$1,300 per home passed, in line with Verizon’s $23bn spend to pass 18mn homes over the past 9 years. The second cost is “connecting” each home – when a customer wants to add Google Fiber service, a truck is rolled out to make a drop connection from the fiber in the street to the home, and equipment is installed in the home, which we estimate at ~$1,000 per home connected.

Total addressable market for Google Fiber estimation

To estimate the total addressable market for Google Fiber, we looked at the number of households reported by the US Census Bureau for each of Google Fiber’s existing 3 metro areas as well as the 9 planned metro areas.

Assuming 50% of these markets are passed and of those passed, 75% are connected, we arrive at total capex spending of $3.3bn that we expect will stretch out over a few years, which we believe is not material for Google, given its strong balance sheet and $11.3bn of Free Cash Flow last year.

For opex, we estimate an average of $60/month/subscriber, or $720/subscriber annually. However, Google Fiber paid packages are $70/month for Gigabit internet only and $120/month for Gigabit internet plus TV, implying that Google Fiber is net profitable.

Our model reflects our optimism around Google Fiber offerings in the licensing & other revenue line, and we continue to believe that Google’s valuation is attractive versus its Internet peers. While our 2015E Net Income estimates are above the Street, we conservatively value Google using a 2015E P/E target of 20x, at the low end of its peer set, and maintain our Buy rating.

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