NQ Logic

Technology | Strategy | Consulting

Valuation Equation

On Oct 3rd, 2006, Google acquired YouTube for US$1.65 billion. After 3 years, almost to the day, Eric Schmidt, CEO/Chairman of the Google declared that he believes “YouTube was worth somewhere around $600 million to $700 million.”

In the past week, most of the columnists on the internet [1] are raising their flags, dispensing their comments along the lines that they too thought at the time that US$ 1.65 billion was too much, and a premium of US$ 1 billion was too large, even in pre-crisis time.

There is no doubt that the second biggest acquisition for Google (after DoubleClick a year later), was a large risk for Google at the time, but when you think about it carefully, this is a great example of the intangible unknown coupled with the synergy parameters in the acquisition equation that every company valuator has to estimate when presented a potential deal sheet.

So How Much Should That Cost?
Every analysis that I saw so far looked into this deal from a revenue point of view. Today YouTube is not profitable and has a major law suit in perspective against Viacom for another US$1 billion. But we should look at it from a cost point of view instead.

New Click Acquisition
YouTube has grown from a US centric 2.5 billion streams/month (85 million streams/day) in July 2006, to 1.2 billion streams/day worldwide by June 2009, a merely 15 times fold in 3 years. The 66 cents a video in 2006, but 3 cents per video at 2009 seems now a very reasonable price to pay in our network economy in which market leader usually takes it all.

Source: comScore Video Metrix , Jan 2009

Brand Equity & Crashing Competitions
Every minute, more than 10 hours of video is uploaded to the site, and YouTube is today the number one video site on the web and by far. This was done from an already envious position I must say, YouTube has a 46 percent share, and MySpace has 23 percent. Google Video has only a 10 percent market share (according to Hitwise) and was in partnership with Yahoo! Video and MSN Video. Not letting YouTube brand and market leadership fall into somebody else’s hands was a must to do at the time that only a premium price would secure. The shutdown by Microsoft of YouTube Rival, MSN Soapbox on Aug 31st this year is a living proof of the right move done 3 years back.

Infrastructure Cost Reduction
Web video is today the highest consumer of space and bandwidth (look at your own hard drive), and by inheriting a [1] very competent team of experts to manage the ever-growing server farm build and [2] infrastructures that could manage the growth, Google fulfilled a need that it was looking for at the time. Today in teaming up the massive storage already in use for the Search with the even more impressive consumption for video, Google had the critical mass to exploit the creation of farm servers around the world deterring even further down the road competitions by the share question of scale (who wants to wait 2 seconds for a search result nowadays?). According to some estimates Google had in 2006 around 450,000 servers spread over at least 25 locations around the world.

What’s Next?
The future looks positively encouraging for YouTube with more and more users watching more and more online videos with more and more bandwidth, comparing the YouTube experience to online streaming TV. The now compile over years of SEO long tail advertisers (SOHO & SME) are few clicks click away from the platform (thanks to an integrated AdWords and AdSense), and majors deals are around the corner with Major Music labels (Warner, Sony) and others movies, TV and content producers (BBC, Sony Pictures, CBS, MGM, Lionsgate).

As Charlene Li (an analyst with Forrester Research) said in Oct 2006 YouTube deal is "expensive but not unreasonable." If only they could find the right formula to incorporate advertising messages to personal videos YouTube will actually be profitable, but Google had already won the long video war with this acquisition battle.

[1] Article References
Greg Sandoval [CNET News] in Schmidt: We paid $1 billion premium for YouTube; Alan Patrick [broadstuff] in Google overpaid for YouTube by c 220%+ ?; Joseph Tartakoff [paidContent] in Google Paid $1 Billion More For YouTube Than It Thought The Site Was Worth; Stan Schroeder [Mashable!] in Google Overpaid YouTube by $1 Billion ... Was it Worth It?; Brad Linder [Download Squad] in You weren't alone in thinking Google overpaid for YouTube; Stuart Miles [Pocket-lint.com] in Google paid $1 billion premium for YouTube; Jay Yarow [Silicon Alley Insider] in Eric Schmidt: Heck Yeah We Paid A Huge Premium For YouTube!

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