Google comes calling

High-tech companies are trying to change the rules of the telecom business. But pushing into telco territory has its risks, writes Fortune's Stephanie N. Mehta.

By Stephanie N. Mehta, Fortune senior writer

(Fortune Magazine) -- A few weeks ago, we wrote about plans by Google and other Silicon Valley companies to make the next generation of wireless networks more Internet-like: Customers would be able to use any mobile device on any network, and access all online content on their cell phones.

But Google (Charts, Fortune 500) and others apparently are not satisfied with simply pushing new services for cell phones or trying to get their content on mobile devices. It and others increasingly are getting into the guts of the wireless business - making phones and perhaps even building wireless networks.

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Is Google CEO Eric Schmidt planning to take the Internet search giant into the telecom business?

Tech stalwart Apple (Charts, Fortune 500) earlier this summer unveiled its iPhone mobile device, and Businessweek reports that the company has looked at buying wireless spectrum (Apple didn't confirm the report).

Google, meanwhile, has been downright aggressive: It operates a Wi-Fi wireless network in Mountain View, Calif. and is widely rumored to be building a wireless phone of its own. In August, CEO Eric Schmidt said the company "probably" would bid on wireless spectrum in an upcoming government auction.

Can these guys really be serious? Why would a traditional technology company want to dive headlong into the highly regulated, capital intensive, commodity business of moving data around?

"I think part of it is hubris," says Tom Evslin, a former Microsoft (Charts, Fortune 500) and AT&T executive who says he supports in theory what Google and other tech companies are trying to do. "They've been very, very successful, and they see what looks to them as a brain-dead telcom world."

Indeed, the phone business has modernized drastically in recent years, in large part thanks to the Internet. Rich content available only on the Web accelerated the deployment of broadband networks, and phone companies today use the Internet to deliver vast streams of voice traffic.

But just as the Internet has changed phone companies, becoming a phone company of sorts - and that's what could happen if Google wins wireless spectrum - would change Google.

In some ways, dipping a toe in the telecom waters has already altered the company. It now has a sophisticated lobbying effort in Washington, D.C., led by Richard Whitt, a veteran of phone company MCI. Until two years ago, Google didn't even have a Washington, D.C. office.

Google wouldn't comment for this column, but it clearly understands the challenges of bidding on - and then building out - nationwide wireless networks. In a July 23 posting on Google's policy blog, Whitt discussed at length the game theory associated with bidding on the spectrum.

Incumbents such as Verizon Wireless - a joint venture of Verizon (Charts, Fortune 500) and Vodafone (Charts) - and AT&T (Charts, Fortune 500) are motivated to make artificially high bids, he noted, in part to keep the spectrum out of the hands of companies such as Google and in part because they can afford to do so: their incremental costs associated with constructing a network are much lower.

What would it cost Google to become a network operator? Google said it would bid a minimum of $4.6 billion for the spectrum if the FCC met a series of open-access conditions Google laid out this summer. (The FCC met Google halfway; now Verizon is seeking a court order blocking the FCC's open-access provisions.)

But let's assume the open-access conditions remain in place and that Google's cost of entry into the wireless business is $4.6 billion for spectrum. (Again, it probably would have to bid much more, because Verizon and AT&T are likely to place higher bids, knowing Google's starting offer.) How much would it then cost the company to build a nationwide, next-generation network from scratch?

It's difficult to tell, but Sprint is spending $5 billion through 2010 to build a 4G, or fourth generation, data-oriented wireless network using a standard called WiMax. That would cover 125 million potential customers - less than half the U.S. population.

Google would have to spend even more than $5 billion. Whereas Sprint has the basic infrastructure - the towers, antennas, fiber-optic lines, routers and switches - in place, Google would have to start at the beginning. (There are also operating expenses to consider, but let's leave those aside for now.)

Even so, Google has a lot of cash on hand. Spending $10 billion or $15 billion to become a wireless operator might not be a financial burden.

So how will investors feel if Google got into the network game? Perhaps they won't care: Google intimations around wireless thus far have done little to hurt the stock. Google trades at a lofty 47 times earnings.

AT&T, on the other hand, trades at 21 times earnings. What would happen if even a small part of Google's business started to look more like a phone company? Would those revenues and earnings garner telco-like P/E ratios? In the case of Time Warner (Charts, Fortune 500), CNN/Money's parent, most days the stock trades pretty much like a cable operator - another capital-intensive business - despite its diverse portfolio of content assets.

As a result, many tech and telecom executives remain skeptical about Google's prospects in the phone world.

Bill Howe, CEO of telecom-gear maker Azaire Networks, says he thinks Google is serious about becoming a phone maker, but says the move won't be easy. "I think it is a big step for them," says Howe, an Intel veteran.

"It was a big step for Apple [with the iPhone], and Apple had built the iPod, it had distribution channels, a well-known brand, and it is a computer maker," says Howe. "Google is a search-engine company."

As for Google's intimations of bidding for wireless spectrum? "Saber-rattling," says Howe.  Top of page