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Google Pays $1.65 Billion for Popular Video Web Site YouTube

October 10, 2006 at 6:20 PM EST
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JEFFREY BROWN: Less than two years ago, YouTube, a do-it-yourself Web site where users can post videos of just about anything, was a figment of the imaginations of two 20-somethings in Silicon Valley. Now, more than 100 million videos are watched every day on the Web site, everything from the ridiculous to the hilarious to the harrowing, soldiers posting videos of their tours in Iraq.

YouTube has its own constellation of improbable homemade stars, like Geriatric1927, a 79-year-old British pensioner named Peter whose videos have been watched millions of times by a viewing audience many decades his junior.

It’s even become a passive player in the political season. Virginia Senator George Allen’s now-infamous “macaca” episode first sped around the Internet on YouTube.

SEN. GEORGE ALLEN (R), Virginia: This fellow here over here with the yellow shirt, Macaca, or whatever his name is…

JEFFREY BROWN: In a short time, YouTube has become a cultural phenomenon, and its success has had some of the Internet’s biggest and wealthiest suitors in hot pursuit. Yesterday, Google won the race. YouTube’s co-founders, Chad Hurley and Steve Chen, announced the deal — where else? — on their own YouTube video.

CHAD HURLEY, Co-Founder, YouTube: Hi, YouTube. This is Chad and Steve. We’re the cofounders of the site, and we just wanted to say thank you. Today, we have some exciting news for you: We’ve been acquired by Google!

JEFFREY BROWN: Google, the dominant Internet search engine, will acquire YouTube for $1.6 billion in stock. Even though YouTube, with its millions of users, has not yet turned a profit, Google is gambling that YouTube is on the leading edge of a fundamental shift in viewing habits, from television to the Internet.

But that bet comes with some big questions, including the legality of copyrighted material that regularly appears on YouTube’s site and whether the quirky community that built YouTube will stick with it as it becomes inevitably more commercialized.

And we look at all this now with Safa Rashtchy, who watches Internet media and marketing for the investment bank Piper Jaffray. For the record, Piper Jaffray has done work for Google and other tech companies.

And Andreas Kluth, technology correspondent for the Economist magazine. His special report on new media called “Among the Audience” appeared in the magazine earlier this year.

YouTube's appeal

Andreas Kluth
Economist Magazine
And that was the first great appeal of YouTube, when it debuted about one year ago, which is that it made uploading video to the web and then viewing it unbelievably simple, so simple that, you know -- foolproof basically.

JEFFREY BROWN: Mr. Kluth, starting with you, explain a bit more the appeal of YouTube. What did it offer that wasn't there before?

ANDREAS KLUTH, Technology Correspondent, Economist Magazine: Well, YouTube started as an idea that the founders, Chad Hurley and Steve Chen, had about a year and a half ago when they were at a dinner party with other geeks, actually technically savvy people, and they discovered that it was very difficult, even for them, to share, to upload and share the home videos they had taken at that dinner party.

So they set out to create a radically simpler way of doing that. And that was the first great appeal of YouTube, when it debuted about one year ago, which is that it made uploading video to the web and then viewing it unbelievably simple, so simple that, you know -- foolproof basically.

And as soon as they did that, all sorts of people discovered that they already had home videos that they would like to share and uploaded it. So that was the initial phase of their growth; that's the initial appeal.

They then very quickly realized at YouTube that there's a second layer of appeal which is this concept of social networking, which is quite fashionable now on the web these days. But it quite simply means that, once you've uploaded content -- in this case, video -- to the Web, most people would like to share it with their friends or the grandmothers to see the baby photos, baby video and so forth.

And so they made, again, very simple -- they put very simple buttons right near the videos where you could rate the video with a star rating so that the more interesting, watchable videos would rise to the top, so that you could e-mail it, so that you can alert others, and general share and network, just as you would in the old days, you know, when people would sit around a face book in college, a paper version, and gossip about it. People started almost gossiping with each other. Just now they were using videos to do it on the Web, which was tremendously appealing.

JEFFREY BROWN: So, Mr. Rashtchy, we talked about the 100 million videos being watched every day. Quite a number. Who's watching it? And what do we know about how people are using it? Is it casually dropping in? Is it instead of watching television, for example?

SAFA RASHTCHY, Managing Director, Piper Jaffray: No, it really isn't instead of watching television. I mean, as Andreas mentioned, it really took off because a lot of people found it very easy to use but also entertaining.

People watch it because there are funny videos in there. People watch it because there are dramatic videos or, more importantly, because videos they relate to.

I mean, YouTube's success is really primarily because it was here at the right time of three major factors converging: One, that broadband penetration is now over 50 percent of households. So a lot of people can upload and download videos easily.

Second, that social networking has taken off. People like to connect with each other, as well as with strangers, by sharing the things that they like, their contents.

And, of course, video content was becoming more and more popular. And I think that's really what helped YouTube propel to the success that it has seen so far.

YouTube's potential money generator

Safa Rashtchy
Piper Jaffray
Our estimate was that, with Google's help -- and that's a very important condition here -- YouTube could possibly generate in the order of $100 million to $300 million next year, which would actually justify the current price that Google paid.

JEFFREY BROWN: So, staying with you, $1.6 billion dollars for a company that doesn't make money. What's the business model? What does Google see? How would this begin to make money?

SAFA RASHTCHY: Well, this would begin to make money by advertising, of course. Now, you mentioned 100 million downloads or viewers of videos every day. That's a very large content consumption that is almost entirely unmonetized now. Monetizing even a small portion of that activity would lead to a significant revenue.

Our estimate was that, with Google's help -- and that's a very important condition here -- YouTube could possibly generate in the order of $100 million to $300 million next year, which would actually justify the current price that Google paid.

But I have to mention that I believe Google's price and their consideration of how to value YouTube was not based on simply what it can generate next year but also on the strategic position that YouTube played in the video landscape and how much importance Google placed on that.

Part of it was defensive. Had YouTube gone to Microsoft or to Yahoo, it would have placed Google in a defensive position, possibly second or maybe third player. So all of those things came into play when they decided to pay that kind of money.

YouTube: dot-com bust?

Andreas Kluth
Economist Magazine
There will be no collateral damage because the exit strategy for the investors of these companies is not a stock market offering but a sale to Google, or Yahoo, or News Corp, or Viacom, or these companies.

JEFFREY BROWN: Mr. Kluth, how do you see the money issue? You know, today there were a lot of parallels being drawn to the dot-com boom and bust era.

ANDREAS KLUTH: Well, the parallels to the dot-com boom and bust, or, well, to the boom, the last bubble, are so obvious that they're also humorous and entertaining. But in some areas, they're misplaced; but in some areas, they're correct.

The correct parallel is, of course, there is a company once again that measures its success in eyeballs or viewers, visitors, as opposed to revenues or profit. And that gets a huge price tag.

But the difference is, of course, in the last dot-com boom or bubble, all these dot-coms made IPOs, stock market offerings, and Main Street investors invested and then got burnt when they collapsed. Here, this little bubble that's being blown now -- and I think there is one -- is very safe in that regard.

There will be no collateral damage because the exit strategy for the investors of these companies is not a stock market offering but a sale to Google, or Yahoo, or News Corp, or Viacom, or these companies.

So the price is not even that interesting in the sense since the only company that would have overpaid is Google, and the stock market seems to love them, the price went up. They have the spare cash. For them, it's small change, about 1 percent of their market capitalization.

And Google, you know, does this all the time. They almost by call options. You know, they put down some money in case they figure out another revenue opportunity down the line. It's true that so far Google has found only one real revenue hit, which is putting advertisements next to search results, but they have dozens and dozens of other things -- this will be the latest -- that they hope in time could be monetized. That's the fashionable term.

So the money, as Safa said, depending on how you look at it, Google certainly has the wherewithal, and the privilege, and leisure to wait until YouTube becomes profitable. And if not, you know, tough luck. They probably won't -- they're probably not losing sleep over it.

What's next for YouTube

Safa Rashtchy
Piper Jaffray
I think that most of the content that is shared by people are generally humorous content, generally personal content. And the copyrighted material are going to be a relatively small part of it.

JEFFREY BROWN: Mr. Rashtchy, explain the legal issues we raised in the set-up, the question of all that copyrighted material that now appears on YouTube. Napster got in trouble for this some years ago; what are the concerns with YouTube?

SAFA RASHTCHY: Well, I think this is different from Napster's case, but the legal issues are an inherent part of social networking that has been taking off on the Web, because, with social networking, people want to share the content that they have created or the content that they like. And sometimes the content they like is copyrighted or is a mix of copyrighted and their own creation.

We think it is a major issue, one that will probably be more important for Google, of course, given that it has over $10 billion or so in cash, so it will be more appealing to potential content creators to sue Google.

However, my view is that it is not one that is going to bring the whole thing to a halt. I think that most of the content that is shared by people are generally humorous content, generally personal content. And the copyrighted material are going to be a relatively small part of it. It will be an issue to deal with; I don't think it will be that big an issue.

JEFFREY BROWN: And, Mr. Rashtchy, just staying with you, finally, we're talking about YouTube as the sort of latest phenomenon here. How quickly can things turn? How quickly could people turn to the next big thing?

SAFA RASHTCHY: That's a good question. It is possible for that to happen; it is difficult, but possible. YouTube has the largest library of videos on the Web right now, and that creates a momentum which prevents people from going to the next best one, as often as they would.

However, we have seen a case -- let's say Friendster was the first social networking site, but it lost to MySpace because it didn't have the appeal that MySpace had created. So it is possible. And I think that played an important role in YouTube's decision to sell to Google, because with Google, it is now a much more defensible site than it would have been alone.

JEFFREY BROWN: All right. We'll watch and see what happens. Safa Rashtchy and Andreas Kluth, thank you both very much.

ANDREAS KLUTH: Thank you.

SAFA RASHTCHY: Thank you.