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Google Investors, Be Careful What You Wish For


The company plans to test very high-speed last-mile services in selected markets. Is it a double-edged sword?

The newswires were all atwitter (not that Twitter) yesterday with the acknowledgment by Google (GOOG) that it plans to test out very high-speed last-mile services in some selected markets. Little is known other than some comments by product managers that it's talking about 1Gb/second speeds, pricing consistent with current offerings, and a commitment to net neutrality.

About five years ago, the world of dark fiber was holding a fire sale. Google piqued the interest of many with the discovery that it was actively acquiring the resource. I'm certain it lit some of the fiber for its own uses, but maybe we're just now seeing the early seeds of its intent.

This is really a double-edged sword for investors and represents the type of situation where you need to be careful what you wish for. Google has a very prosperous margin structure and there are few new revenue streams that would add to that. In reality, most would be a margin drag.

It's easier to demonstrate what I'm talking about by speculating on the potential impact of another recent announcement -- Nexus One. The Street bubbled about this smartphone in the weeks leading up to its debut at the Consumer Electronic Show in January. Despite the buzz, it's another Android phone and will have to compete with other Android phones. But what if it's successful, as successful, say, as Research In Motion (RIMM) was last year? Exactly what does that do to Google's business model?

Just for fun, let's take Street consensus for Google in 2010 and pretend that the Nexus One delivered Blackberry-like results. Thirty-four million units generated a little over $14 billion for Research in Motion over the last 12 months. However, the operating margin on that revenue was 21%, far lower than Google's 35%.

But the Nexus One has maybe a dozen essentially identical competitors in the Android world. What if the Nexus One can only deliver operating margins equivalent to a competitive cell phone or around 10%? More margin pressure!

Granted this is unlikely to happen over the course of one year, but it's the direction margins are headed that counts and it's not what most Google investors signed on for.

Now, take this scenario one step further. Let's pretend that Google ramps up a very capital intensive, low margin, high-speed networking operation. You know the rest of that story.
No positions in stocks mentioned.
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