In a year when so much already looks different and fresh at one of the world's most powerful tech companies, Alphabet's coming launch of its long-touted YouTube subscription service threatens to upend the current media landscape.
As one might expect, this historic move has the analyst community buzzing, with at least one analyst arguing that YouTube alone deserves a valuation of a once-unthinkable $100 billion. So how did YouTube get here, and how justified are some of these eye-popping valuations? Let's take a look.
The rise of Alphabet's media giant
YouTube has had a remarkable ascent to one of the most powerful names in online media. Founded by three former PayPal Holdings employees, long before PayPal's recent spinoff, YouTube exploded in popularity, consistently ranking as the third most visited website in the world behind Google's homepage and Facebook.And given the size of its audience, YouTube's cultural importance is hard to overstate. It has enabled artists to create a fresh outlet for their work and helped fan the flames of revolution for better and worse.
It was this massive latent potential that led then-Google to acquire YouTube for what seemed like an astronomical $1.65 billion in late 2006, a sum former Google CEO and current Executive Chairman Eric Schmidt has since admitted included a whopping $1 billion premium. Since then, YouTube's popularity has exploded, while its business model remains in flux. The company remains effectively unprofitable, and a potential subscription option has long been discussed as a possible remedy to its economic issues.
Google first introduced a pilot subscription service for a small sampling of YouTube channels in 2013, charging users $0.99 per month to access premium content from a range of independent content creators and established brand names such as Sesame Street. And though the program was never widely adopted, the idea of a subscription monetization model obviously remained on YouTube execs' minds. Although an exact date has yet to emerge, reports say a launch is imminent.
According to The Wall Street Journal, YouTube has secured support from many of media's most important content creators, including Time Warner's Turner cable unit, 21st Century Fox's Fox Sports networks, and Comcast's NBCUniversal. The service will reportedly cost $10 a month and will include access to music, user-generated video, and branded third-party video, although the exact breakdown isn't immediately clear. Given its massive user base, even moderate adoption rates could turn YouTube's subscription service into a meaningful financial driver. However, even then, I'm not so sure the $100 billion valuation some analysts attribute to YouTube makes sense at the moment.
Is $100 billion too far-fetched for YouTube?
That valuation estimate comes from Atlantic Equities research analyst James Cordwell, who mentioned it in a note touching on the Alphabet reorganization. Cordwell correctly notes that YouTube's growth runway remains significant, with his valuation calling for 50% average annual revenue growth through its FY 2018. Producing an estimated $15 billion in revenue by 2018 might sound aggressive, but it's in keeping with recent YouTube growth rates, and adding more premium content as part of its subscription service rollout could well help support this growth for years to come.
If that happens, YouTube would have a price-to-sales ratio of roughly 5.5. For context, Alphabet as a whole currently trades at a 6.6 P/S ratio, so this claim isn't totally detached from reality. However, it says nothing about potential profits, which YouTube currently lacks.
So rather than projecting out my own margins for YouTube and comparing, I'll simply say that this $100 billion price tag for YouTube seems directionally accurate if slightly inflated, given what we know of the dominant online video platforms, its plans, and its current finances. What's important here, and what the $100 billion valuation touches on, is that YouTube is a uniquely valuable business because it has a product that people love. And as Internet penetration rises, mobile usage makes streaming videos anytime simpler -- and as YouTube brings more in-demand content onto its platform, its economic value will only increase.
With the increasingly sprawling nature of Alphabet and Google, it can be easy to lose sight of the potential value of more removed units such as YouTube. And especially given YouTube's coming subscription tier, Alphabet and tech investors should keep in mind how important, and valuable, a property YouTube is likely to become.
Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. The Motley Fool recommends Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.