News Flash: YouTube Makes Money!

It's not quite official, but I don't see any reason to doubt it anymore: YouTube is profitable. Probably has been for years, too.

What makes you so sure, genius?
Google (Nasdaq: GOOG  ) is notoriously tight-lipped about the financial performance of its many operations and subsidiaries, the world's largest online video service included. Analysts and pundits alike have been forced to jump to conclusions about YouTube for years, based on general knowledge of the costs of running an online business and assumptions regarding YouTube's revenues. And those calculations have tended to show YouTube in a red, unprofitable light.

For instance, a Credit Suisse analyst came up with about $240 million in potential 2009 revenue from advertising and direct sales but more than $700 million of operating costs, resulting in something like a $470 million loss. Long-tail economics expert Chris Anderson sees YouTube turning a profit by 2014, maybe, if Google plays its cards right.

Yeah, so?
And that's where the Viacom (NYSE: VIA  ) lawsuit comes in. To bolster its case that YouTube makes dirty money off Viacom's precious content, the media giant filed copies of YouTube's financial statements from before the Google era. In April of 2006, Forbes estimated that YouTube paid $1 million a month in bandwidth costs alone with 13 million unique visitors monthly. Three months later, traffic had grown to 20 million visitors.

You would think that expenses would rise in lockstep with the site's popularity, and Viacom's documents show that this was the case. The visitor count ballooned 54% between April and August, 2006, while operating costs more than doubled as YouTube outgrew third-party hosting and started building an infrastructure all its own. But at the same time, revenue skyrocketed. By August, YouTube turned a respectable $575,000 in gross profit thanks to banner ads and revenue-sharing licensing deals.

When you assume ...
That was in the early days of YouTubing, and Google has taken many steps since then to monetize the service further. Google CEO Eric Schmidt said earlier this year that "We've figured it out. Nowadays, just about every advertising campaign involves YouTube as part of the solution. That's a big deal." It has long been thought that only 5% or less of YouTube's page views are monetized at all, but that assumption is old and wrong.

Premium content partners like Sony (NYSE: SNE  ) and Time Warner (NYSE: TWX  ) keep YouTube crammed with videos that are more than just random shots from private cameras, and the ever-popular batches of music videos point viewers onward to buy the song from Apple's (Nasdaq: AAPL  ) iTunes and Amazon's (Nasdaq: AMZN  ) MP3 store. Google claims to sell out YouTube's ad space habitually. There's much more money flowing in here than anybody gives YouTube credit for -- and it began with a sprint off the starting line.

That's one side of the equation sorted out, but YouTube's expenses have probably been overestimated, too. YouTube used to rely on third-party content delivery services to keep its videos flowing without hiccups, but Google has invested heavily in networking infrastructure and is now pretty much its own content delivery provider. Akamai (Nasdaq: AKAM  ) made waves recently by cutting prices for preferred partners to as low as $0.015 per gigabyte delivered. If that was a cheaper or better offer than what Google can do for itself, you can bet that Big G would be knocking on Akamai's door, but that ain't happening.

Google cuts bandwidth costs through peering agreements with other networks, meaning that the networks pass data back and forth without money changing hands. The fiber networking initiative shows how serious Google is about infrastructure, and all of its businesses benefit from efficient, low-cost networking. YouTube is no exception.

What it all means
So estimating YouTube's 2009 expenses at $700 million could be based on outdated assumptions, and the same is true for a low $500 million sales projection. Management comments are pointing in this direction, and the Viacom filings add fuel to the fire. If you think you'd notice because Google would have to break it all out in quarterly filings, consider the fact that most of YouTube's sales still fall under the umbrella of advertising -- where nearly all of Google's sales happen anyway.

Until Google opens its corporate clamshell and starts talking about YouTube's results in detail -- which I guess won't happen anytime soon -- we're all left scratching our heads on the sidelines and wondering just how much money the company is making from online videos lightly wrapped in marketing messages. But one thing seems clear to me: YouTube makes money today, and that's not even news. I'm just wondering how much.

Did Google overpay for YouTube back in 2007, or is the company just bad at broadcasting just how great a bargain it got? Discuss in the comment box below.

Fool contributor Anders Bylund owns shares in Akamai and Google, but he holds no other position in any of the companies discussed here. Akamai Technologies and Google are Motley Fool Rule Breakers selections. Apple and Amazon.com are Motley Fool Stock Advisor picks. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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