Updated: Checkout the Valuecruncher Valuation model used and enter your own assumptions- Valuecruncher Valuation Model – YouTube
Google has recently announced plans to introduce a new overlay styled advertising model for YouTube. The model involves overlaying a semi-transparent ad across the bottom 20% of the video. The overlay appears after 15 seconds of the video and last for 10 seconds with viewers having the option to click on the ad. The overlay model is the result of trials of various advertising formats that included pre-rolls.
The initial release will involve overlay advertising on videos provided by YouTube’s content partners. The advertising revenue will be shared with content partners using a similar model to the Google Adsense network.
This announcement is significant in that it represents the first attempt by Google to monetize their $1.65 billion acquisition of YouTube beyond traditional text and banner advertising. Google acquired YouTube nearly 12 months ago and it has yet to generate significant revenues:
Revenues realized through the Google Print Ads Program, Google Audio Ads, Google Video, Google TV Ads, Google Checkout and YouTube were not material in any of the periods presented. Google 10-Q, 30 June 2007
In a wider context-how the overlay framework will be received will be significant for online video in general, until now revenue models involving pre-roll advertising have not been well received by viewers.
The announcement of the overlay framework has generated a range of analysis including a number of posts on Silicon Alley Insider (SAI) estimating the potential revenue YouTube could generate from in-video advertising.
Economics of Online Video 1
Economics of Online Video 2
Analyzing YouTube’s Revenue Potential
SAI’s analysis includes estimates of YouTube’s operating expenses.
Valuecruncher has built a high-level valuation model for YouTube incorporating the SAI analysis of the overlay revenue model, Valuecruncher’s analysis of the opportunity and a range of other online sources. The valuation model is designed to value YouTube as an independent entity with revenues coming from both in-video advertising and traditional online advertising (Adsense and banners).
The total number of videos streamed is important for estimating the costs associated with operating the YouTube. These costs include streaming and storage. Based on ComScore data United States viewers watched 2.4 billion videos at YouTube in July 2007. In August 2006 the United States accounted for approximately 22% of all YouTube’s streaming activity. Valuecruncher has assumed an average of 15 billion videos will be streamed worldwide per month in 2008 increasing to 50 billion per month in 2012. This is an aggressive growth rate that is very subjective. Valuecruncher believes that based on YouTube’s current audience and the projected increase in time spent online this growth is achievable. If YouTube can establish a sustainable revenue model for online video combined with its audience dominance it will become the default online distribution channel for content providers.
YouTube is implementing the overlay ads on videos provided by content partners. The percentage monetized represents the portion of YouTube’s video servings that will contain advertising. Valuecruncher has utilized SAI estimate that 30% of YouTube’s servings will be monetized. Google does not disclose what portion of YouTube’s inventory content partners supply and it is uncertain what percentage of “individual” generated content would be monetized.
Content Royalty ‘
The content royalty represents the percentage of the advertising revenue that is distributed to content providers. This model is similar to the Adsense framework. We have estimated that 60% of the advertising revenue will be passed onto content providers. This is lower than the estimated 85% paid out in the Adsense framework. The lower content royalty reflects the higher costs associated with delivering the video content.
The CPM rate reflects the price paid by advertisers per 1,000 overlays. Valuecruncher has used an estimated CPM rate of $20.
Storage & Streaming Expenses
Valuecruncher utilizes the SAI’s analysis and assumes storage and streaming expenses of $1.20 per 1,000 videos streamed. These expenses are expected to drop to $0.23 per 1,000 videos streamed by 2012. The assumed decline in delivery costs is based on streaming costs falling at a greater rate than video file sizes increase.
Sales, General and Administration (SG&A) Expenses
SG&A expenses are estimated at 15% of revenues based on Google’s SG&A.
Research and Development (R&D)
YouTube’s R&D is estimated at 10% of revenues and is expensed not capitalized.
Valuecruncher assumes that YouTube will be able to generate additional revenues via Adsense and banners. Valuecruncher has assumed a CPM rate of $0.75 and for simplicity has applied this to the total number of videos streamed.
Cost of Capital
Valuecruncher uses a cost of capital of 15% for YouTube, this is higher than the 12% used by analysts for Google. Valuecruncher believes the uncertainty surrounding the acceptance of the overlay intrusion and CPM rates advertisers will pay justifies the higher cost of capital.
Valuecruncher has used a long-term growth rate of 7%, this growth rate represents the potential of online video beyond the 2012.
Based on the assumptions above Valuecruncher estimates the enterprise value of YouTube at $4.91 billion (this point estimate is very sensitive to a number of subjective assumptions and Valuecruncher encourages readers to interrogate the valuation by adjusting some of the assumptions – Valuecruncher Valuation Model – YouTube). This represents $15.73 per share for Google shareholders or 3.0% of Google’s value (based on a share price of $522.65). Google is currently trading at an EV/EBITDA multiple of 29.14. The YouTube valuation implies an EV/EBITDA multiple of 52.77 based 2008 EBITDA, this is relatively high multiple reflects the significant growth expected over the next 5 years. Based on analysts forecasts for Google and Valuecruncher’s projections YouTube will represent 9.3 % of Google’s revenues ($3.65 billion of $39 billion) and 3.4% of Googles EBITDA ($645 million of $19 billion) in 2011. Google’s current EBITDA margins are approximately 38% driven by Google Adwords. The delivery costs and revenue sharing of associated with online video content contribute to significantly lower EBITDA margins for YouTube (24% in 2012 in Valuecruncher’s financial projections).
Based on Valuecruncher’s projections YouTube’s ad overlay revenues would represent approximately 4.4 % of online advertising (based of PwC estimates) and approximately 32% of online video advertising in 2011.
This valuation involves a number of very subjective assumptions and considerable uncertainty.
Key issues include:
Viewer response to the overlay advertising; will they reject the intrusion and exit the videos?
How viewers respond will be crucial to determining what CPM rates advertisers are willing to pay.
What percentage of videos advertisers will be prepared to advertise in?
How will YouTube match advertisers with content and visitors?
Although the overlay model has been trialed it is still unproved with a mass audience. Other revenue models may emerge including a cost per click framework in place of or in conjunction with the CPM framework that could have a significant impact on YouTube’s valuation.
YouTube’s potential margins are dramatically reduced by monetized content subsidizing the cost of delivering “non-commercial” content.
Will YouTube continue to dominate the online video space or will competitors that focus on a purely “premium” content (i.e not have the cost cost of serving non-monetizable content) develop a superior business model?
In the online world there are two key metrics; eyeballs and content and these two metrics are very highly correlated. At the moment YouTube dominate both of these categories but it will be interesting to observe how this changes as more “premium content” moves online. Will YouTube become the online broadcaster of choice for content providers?
A key issue that this valuation reiterates is that “content is king”. A significant portion of the projected growth in the online advertising spend will be realized by content providers not the distribution channels. This is the model that businesses such as WatchMojo are looking to capitalize on.
Did YouTube’s founders miss out when they sold for $1.65 billion?
YouTube has grown significantly since the Google acquisition in October 2006. At the time of acquisition YouTube was at best operating at breakeven, facing legal action and had no sustainable business model in place. The Valuecruncher valuation may underestimate the uncertainty surrounding the advertising potential but based on the uncertainty that existed at the time of the acquisition and the costs associated with scaling YouTube to the size it is today the acquisition price of $1.65 billion is still a great result for the YouTube founders.