By Alexei Oreskovic and Poornima Gupta
SAN FRANCISCO (Reuters) - Google Inc took its biggest step to go deeper into consumers' homes, announcing a $3.2 billion deal to buy smart thermostat and smoke alarm-maker Nest Labs Inc, scooping up a promising line of products and a prized design team led by the "godfather" of the iPod.
Nest will continue to operate as its own distinct brand after the all-cash deal closes, Google said on Monday.
The deal is the second largest in Google's history after the $12.5 billion acquisition of mobile phone maker Motorola in 2012.
Like the Motorola deal, which marked Google's first major foray into hardware, the Nest acquisition gives Google a stepping stone into an important new market at a time when consumer appliances and Internet services are increasingly merging.
"Nest Labs appears to be focused on thermostats and smoke alarms, but it's not far-fetched to see Google expanding this technology into other devices over time," said Shyam Patil, an analyst at Wedbush.
"Home automation is one of the bigger opportunities when you talk about the Internet of everything and connecting everything. This acquisition furthers their strategy around that," he said.
Shares of Google were up 0.5 percent at $1,128.49 in extended trading on Monday.
Nest gained a large following with its first thermostat - a round, brushed-metal device with a convex glass screen that displays temperature and changes hue to match the color of the wall it attaches to. It also tracks usage and employs that data to automatically set heating and cooling temperatures.
With the acquisition, Google gets Tony Fadell, a well-connected and well-respected Silicon Valley entrepreneur credited with creating Apple Inc's iconic iPod music player, along with co-founder Matt Rogers and a host of talented engineers and designers.
According to a search on professional network LinkedIn, roughly 100 of Nest's 300 employees have worked at Apple in the past.
Google, the world's largest online search engine, is increasingly expanding into new markets, with efforts ranging from a high-speed Internet access business to advanced research on self-driving cars and robotics.
But while Google's engineering expertise has generated major advances in technology, the company has at times struggled to create hardware products that resonate with consumers as much as Apple's products do.
The consumer experience of Nest's products "is Apple-like and it gives Google that," said Pat Moorhead, an analyst at Moor Insights and Strategy.
"What Google wants to do is be the backbone for your home, how you consume energy, how you consume content like music through your entire house," said Moorhead.
Some commenters on Twitter expressed concerns about the privacy implications of the deal for Google, which collects scads of personal data about its users' online habits.
"Not content with your personal data, Google now wants your home data by buying Nest," read a Tweet by Irene Ng.
"So basically Google will know when homeowner is away, when they've had a fire & what the power bill is?" Tweeted Brian Makas, who appended the hashtag #creepy to his comment.
In an interview with Reuters, Nest's Fadell said the company spent a lot of time discussing privacy issues with Google during talks that led to the deal.
"The reality of the situation is inside of Google they take privacy so incredibly seriously you have no idea," Fadell said, noting that Nest's terms of service would not change after the deal.
Google said the deal is expected to close in the next few months pending regulatory approval.
Google has tried to gain a foothold in the smart home market before, launching the PowerMeter service in 2009. The service let consumers use the Web to monitor their home electricity consumption, but Google shut it down in 2011, noting that it hadn't caught on as much as Google hoped.
It was that same year that Nest's Fadell met with Google co-founder Sergey Brin at a TED conference, showing him a prototype of the thermostat. Google's venture capital arm, Google Ventures, made an investment in Nest not long after that.
Kleiner Perkins Caufield & Byers, the venture-capital firm that started backing Nest in 2010, made a return of 20 times on the $20 million it has put in over the years, for a return of around $400 million, a person familiar with the situation said. Shasta Ventures, which invested at the same time as Kleiner, stands to make a similar rate of return on its investment, a person familiar with the matter said.
Fadell said the deal with Google was the culmination of "countless" discussions that began in the summer of 2013.
"It took us months to get comfortable that they are going to bring to the table the things we need for scale and to realize our decade-long vision and that they really truly respected what we did," he said.
While Fadell's expertise in mobile products could be a boon to Google and its money-losing Motorola smartphone division, he stressed that his focus was on home automation products.
"That was one thing I was very clear about. I said ‘Larry, I have already built all kind of mobile products, I have done all those things. I am not here to build those,'" Fadell said, referring to Google CEO Larry Page.
"I am here to build out this vision. Not to go and build the other things I have already built in the past," said Fadell.
(Additional reporting by Noel Randewich and Sarah McBride; Editing by Jonathan Oatis and Ken Wills)