Google: YouTube Poised To Explode

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Overview

Google’s (NASDAQ:GOOG) (NASDAQ:GOOGL) YouTube brand has long been a household name since it was acquired in 2006. The website has “more than 1 billion monthly users watching hundreds of millions of hours every day” (3Q16 Earnings CC). More importantly, it holds a large stake in the digital video advertising market which has been growing at a compounded annual growth rate (CAGR) over 30%. The half-year report from the Interactive Advertising Bureau (IAB) supports that this trend will continue into 2020, resulting in top-line growth for Google.

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IAB Digital Advertising Findings

The IAB recently published the half year results for 2016 in digital advertising. By far, digital video advertising-related revenue has seen some of the most substantial growth in the industry:

Source: IAB / PwC US Entertainment & Media Outlook

The high CAGR present in digital video advertising illustrates the importance of YouTube to Google’s future growth prospects. Sell-side analyst Morgan Stanley projects a year over year growth of 47% in YouTube revenues this year with UBS Research projecting a similar growth rate in its baseline model. Despite the current high rate of growth, one can still expect to see CAGR remain at 20% for desktop and 30% for mobile through 2020. Keep in mind those figures are for the industry – it’s projected YouTube will do even better. In fact, digital video advertising is the only desktop related advertising that grew substantially year over year (13%).

In mobile, we see explosive growth in the triple digits since HY2015 which helps offset its higher traffic acquisition cost (TAC). Both desktop and mobile digital video advertising revenues are growing at substantial rates relative to other advertising formats. Google executives have mentioned on several occasions that while it may seem that mobile cannibalizes desktop, the reality is that it is in addition. The slowed down rate of growth in desktop is expected due to the maturity of the desktop advertising market relative to mobile. Furthermore, mobile monetization is becoming increasingly optimized, which should lower TAC in the long run.

Source: IAB / PwC US Entertainment & Media Outlook

Here, we see in the US alone that digital video advertising is estimated to be as large as $23.5B by 2020. Keep in mind that an estimated 80% of YouTube’s traffic comes internationally. This means that this $23.5B figure is a gross underestimation of the true market size. However, it is also crucial to note a bulk of global advertising revenues is centered in the United States and that CPM and CPC are lower worldwide.

Almost as important, however, is that 77% of this ad revenue is anticipated not to be related to broadcasters. In other words, YouTube’s home domain, where it holds majority market share over other alternatives such as Vimeo, AOL, Dailymotion and Instagram (NASDAQ:FB), will be where 77% of digital video advertising revenue is centered. Maybe that explains digital video advertising’s high estimated CAGR, which is over six times as large as the whole industry’s estimated 3.3% CAGR (taken from IBISWorld Industry Reports).

Profitability

One of the large concerns with YouTube is its profitability. Google has been less than transparent about the revenue and cost of revenue related to any of its businesses, including YouTube unfortunately. Instead, it aggregates these businesses into broadly sweeping categories. The category YouTube belongs to is “Google websites,” which contributed $16.1B or 72.3% of the Google segment top-line in 3Q16. We don’t know how much exactly YouTube contributes to this top-line figure, but it is estimated to be around $3.1B for 3Q16 by Wedbush.

Regardless of the exact number, we know YouTube brings in a large amount of revenue, but what about profit? This is where Google is dodgier and this lack of transparency is the only dampener (albeit major) on YouTube’s future prospects. Here’s some of what we do know:

  • Cost-per-click (CPC) is lower for YouTube and this is a key driver behind why we’re seeing consistent declines in aggregate CPC (product mix is shifting towards YouTube). A large part of this is because TrueView ads are only paid for when a user interacts with the ad (by clicking or watching 30 seconds or until the end, whichever is shorter).
  • YouTube receives approximately 45% of the advertiser payments (the rest goes to content creators).
  • 2015 saw an influx of articles suggesting the business is breakeven, although the credibility of these is not certain since they all cite the original WSJ article which doesn’t cite any real source (“according to a person with knowledge of the figure”).
  • Susan Wojcicki mentioned during the Fortune Most Powerful Women summit that they are “still in investment mode” and that “there’s no timetable” for profitability.

On the last point, it seems there may be some credibility to the statement that the business isn’t generating a profit, although it’s also possible that it is generating a profit and it is automatically being reinvested back into the platform. I tend to believe it is the latter, but I dislike that Google has forced us to guess in the first place.

Conclusion

IAB’s recent half year report on digital advertising shows supporting evidence that digital video advertising will continue to see explosive growth through 2020. More importantly, the majority of this advertising revenue will be non-broadcaster related. YouTube’s market share and business model is the best positioned to take advantage of the growth in the industry. YouTube reaches more people between 18-49 years old on mobile than any TV, cable or broadcast according to Jefferies.

With the newer bumper ads (6 second unskippable ads), in addition with traditional TrueView ads, YouTube is seeing improved monetization of mobile advertisement. That’s key given that mobile recently overtook desktop Search as the predominant ad format. Although the TAC related to mobile advertisement is higher, we can expect the margins to improve over time as Google further optimizes mobile advertising.

The largest concern with YouTube is the lack of transparency by Google on its performance. We know the business generates tons of revenue (estimated $11.7B for FY2016 according to Wedbush), but how much it contributes to the bottom-line is uncertain. We know from Susan Wojcicki that profit is not a priority right now, which is acceptable given the high double-digit growth. Despite Google’s opaque reporting, one can expect YouTube to be a key component in Google’s performance through 2020 and beyond with its industry leading growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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