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!