Youtube Fairness Opinion

KD has decided that he should do a fairness of valuation opinion because in all honesty, it should be done. Sequoia is the largest shareholder of Google as well as YouTube so there are obviously some conflict of interests here. I have mixed feelings about the Youtube acquisition because I have not been able to determine whether the valuation was fair. I think that Youtube has built a great website and product for its customers, but they only began to scratch the surface of their business model. Let's dig in and see if there is more "meat on the chicken".

Many people claim that Youtube did not make any money but I fail to believe that. Here are the reasons:

First, they did have some unique video advertisements and also adwords. And if you know anything about online ads now, you know that one can build a business simply by Google Adsense. If you have 34M uniques, by GOD, someone is clicking through those adds! In addition to those, just before the acquisition, Youtube did strike several deals with large media houses.

Secondly, Youtube raised $8M on the first of April. LEt's do a quick cash flow extrapolation. They had 67 employees so they are burning $500k in opex and another $1M in bandwidth per month. But this obviously ramps up so let's say they burn $2-3M per month. Youtube funded the 8 months of the operation with $8M so the net burn was clearly less than $1M per month. Therefore, they were probably doing a few million per month in revenues before the acquisition and probably break even or higher the month before the acquisition ($3-4M) so they would not have to raise another round of financing. I don't think Google would buy a company about to go bankrupt, do you?

With that, there was an inherent projectable value in the business. Then, I'm sure Mr. Mckinsey, CFO Paypal, Roelof built some large financial model justifying the long term value of each unique monthly visitor to a potential acquirer. In fact, several weeks before the acquisition he said the company was worth $1.5bn.

Why wouldn't a savvy CEO have strung them out? Did buying them now prevent them from being a $2,3,10bn acquisition 2 years from now? What if Google waited for them to raise another round of financing and to build a more substantial business model? Let's investigate the valuation.

1) So let's assume that 1 year later they built a company with $10M per month from the content deals and adwords in gross revenues (because Chad said that he could in a newspaper article) and they have to share 50% with the content holders and others so they actually make $5M per month. As previously stated, they had 67 employees so they are burning $500k in opex and another $1M in bandwidth per month. But this obviously ramps up so let's say they burn $2-3M per month which yields a NPAT of about 1.2M per month or about 15M per year. Google trades at 60P/E so they pay the same multiple for YouTube, assuming a PE/G of 1:1 and the projected valuation is $900M. If you tube grows its earnings faster than that, say 2x, then a P/E of double that is justified and so is a $1.8bn valuation. An IPO in 2-3 years could have well exceeded that number.

2) According to Techcrunch, Viacom acquired iFilm and AtomShockwave (3.3M and 1.3M uniques per month) for $50M and $200M respectively suggesting per user value of $15 to 150 per unique). Sony acquired Grouper for 65M which was about 100 per unique. The Japanese have a tendancy to overpay for US entitities so we have to discount this. Youtube had 34M uniques per month suggesting a fair value of $3.4bn. Google only paid $48 per eyeball.

3) Google paid Myspace $900M to embed its search bar which is a deal they are definately not losing money on. Google is not going to hurt its gross margins of 60% so they probably are making about $1.5bn in revenues on that deal (60% of 1.5bn is 900M). Assuming Google would pay YouTube the same for such a deal and then have access to a whole new medium of media why not just pay $1.5bn for complete ownership of the website and they breakeven on an embedded search deal. It makes sense to me.

4) Lastly, Youtube does not represent a new medium for watching TV. I don't think people will watch TV shows on Youtube. People merely are entertaining themselves by watching their videos and their friends videos. I don't think any of this crazy legal issues are issues at all. Not many people are going to watch CBS, NBC, ESPN shows and so forth. All people want to see is someone fall of their bike or throw a pie in someone's face. This is the new medium and one that no large media company can capture and no one every will again.

KD's final assessment on the YouTube deal is I think Youtube got the short end of the stick. They should have held out for $2bn. I also think it was savvy for Youtube to sell now, not because of the legal risk which I discount, but because they had peaked the success of the website without having a partner like Google.

KD