Can Google squeeze enough out of YouTube to recoup $1.65 billion investment?

Posted Oct 9th 2006 8:59PM by Peter Cohan
Filed under: Deals, Newspapers, Rants and Raves, Google (GOOG)

The business media is all atwitter over Google Inc's (NASDAQ: GOOG) $1.65 billion stock deal for the video site, YouTube. As reported in the New York Times, YouTube has 50 million users and it's losing money. So Google is paying $33 per YouTube user. Is that a lot or a little?

In my opinion, that depends on whether Google can figure out a way for YouTube to generate sufficient profits to offer Google a return on its $1.65 billion investment -- which represents 1.3% of its $132 billion market value. The New York Times notes that Sequoia Capital, an original Google investor (other Sequoia wins include Oracle, Apple, Cisco, and Yahoo), paid $11.5 million for a 30% stake in YouTube worth $495 million. Sequoia generated a 42,043% return on investment for Sequoia -- not bad for less than a year's work!

To earn back its $1.65 billion, I estimate that Google will need to squeeze $26 million in profit (not toothpaste) out of YouTube. (I base this on the assumption that the market would value each dollar of YouTube earnings at Google's P/E of 63).

It doesn't sound like much of a challenge for Google but it's not clear from whence the profits will emerge. Based on the conference call at the deal announcement, it sounds like Google plans to make money off of video search and that it considers advertising a distinctly secondary source of profit.

What confuses me about this is that Google makes money off of little text advertisements placed next to search results – so to think of video search as a source of revenue distinct from advertising leaves me scratching my head. But since the deal is so tiny from Google's perspective, it almost doesn't matter whether it makes money or not.

Nevertheless, I'd like to think that Google management is smart enough to figure out how to make some money off the investment -- though they'd be hard-pressed to do as well as Sequoia!

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in Google.

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Reader Comments (Page 1 of 1)

10-09-2006 @ 10:11PM

JOE HANON said...

In your article you write: "...FROM WHENCE."
As a matter of correct grammar it should simple be written: "whence."

"from whence" is redundant and incorrect.

10-17-2006 @ 2:41AM

jason weaver said...

Google will probally intagrate video.google.com with youtube, and google will most likley take you tube a step further and let the viewer download videos for there ipod/psp

10-09-2006 @ 11:12PM

John said...

You bet they can!

10-10-2006 @ 12:55AM

Gary E. Sattler said...

OH DEAR!

Me thinks Google is preparing to blast the wheels off this here internet!

My spidey sense tells me that the obvious options are not what Google has in mind at all.

Google has just purchased a platform. At $33.00 per existing customer they got a bargain. I'm guessing they'll "net" their entire investment within two years... but I'm figuring straight cash in and straight cash out... and that, from the time they actually establish what I think is coming.

If they're laying the groundwork for what I expect they are, you bet advertising will be a secondary source of income.

I'm expecting that computer hardware manufacturers are going to be buying the Google guys a lot of nice lunches.

I can't wait to see what develops.

10-10-2006 @ 1:47AM

Mr Wave Theory said...

With that big $1.65 billion price tag, you bet everyone is wondering who is going to get bought next after YouTube? Google (Nasdaq GOOG) is out of the game but there are many more buyers. I took a look at Yahoo's directory of video sharing services, DMOZ, etc. - hey, Yahoo! Inc. (Nasdaq YHOO) is good for something too you know. They have a great directory. Here they are. My 25 sites that can be bought next in no particular order.

1) PutFile
2) Ourmedia
3) ZippyVideos
4) Vimeo
5) Metacafe
6) Veoh
7) DailyMotion
8) Castpost
9) Revver
10) VideoEgg
11) Str8Up
12) Dropshots
13) GoFish
14) VidiLife
15) Eyespot
16) StreetFire
17) Clipshack
18) VideoSift
19) Videobomb
20) vMix
21) MotionBox
22) vSocial
23) VapShare
24) Pickle
25) 247Show

http://mrwavetheory.blogspot.com/2006/10/who-will-get-bought-next-after-youtube.html

10-10-2006 @ 8:22AM

Peter Cohan said...

One thing I forgot to mention -- in anticipation of its YouTube announcement after the market close on Monday, Google's stock added $9 a share -- which boosted its market capitalization by $2.7 billion. Assuming that the stock price rise was due to the deal, Google has already gotten back its $1.65 billion YouTube purchase price with $1 billion to spare!

10-12-2006 @ 12:09AM

Mr Wave Theory said...

Below are the Google (Nasdasq GOOG)/ Youtube comments from Wall Street Analysts. All of the firms below make markets in Google stock and/or options, so take their advice with a grain - make that 2 grains - of salt.

While it is counter to Google's general preference to build rather than buy, and the company already has a similar offering in Google Video, we believe Google recognizes the value of YouTube's leadership position and its strong brand name in the fast-growing video space. … By owning YouTube, Google may be able to bring content holders to the negotiating table earlier and in a more strategic way than otherwise might be possible.
--Douglas Anmuth at Lehman Brothers, who has an "overweight" rating and $530 price target
* * *
http://mrwavetheory.blogspot.com/2006/10/google-youtube-wall-street-analyst.html