Google: Is YouTube’s Potential Exponential Growth Hidden In Plain Sight?

Google: Is YouTube’s Potential Exponential Growth Hidden In Plain Sight?

The market has no idea how to value Google’s YouTube (GOOG) (NASDAQ:GOOGL). YouTube is often compared to Netflix (NASDAQ:NFLX), and although Netflix’s valuation is certainly a subject of controversy, at least we generally know the Netflix business model and financial results and have detailed disclosures regarding their content creation and acquisition costs. And we know that the market currently values Netflix at around $80 billion.

Contrast that with YouTube. Its results are lumped into the “Google” segment so we don’t know much about its financials. We don’t know much about content acquisition. We don’t really know the long-term business model, with services like YouTube Red, YouTube TV, YouTube Originals and others seemingly deviating from the core user-generated content. As far as I can tell, we don’t even know if YouTube is profitable.

What we do know about YouTube is that it’s growing very quickly. The latest numbers are 1.5 billion monthly viewers. People watch an average of 60 minutes a day on their phones and tablets. YouTube, along with mobile advertising, were the primary drivers of Google’s results this quarter. We also know that the fastest growing stream for YouTube is watch time on TV screens, which nearly doubled year on year.

YouTube Transforming Right in Front of Us

I believe that this last data point shows how YouTube is transforming right in front of us, and this particular type of growth will lead to exponential growth in revenues, profitability and margins.

I believe a confluence of several factors at once have led to YouTube being the most engaging and interesting “platform” for living room TV viewing.

First, processors in embedded “smart TV” software or third-party boxes (AppleTV, Chromecast, etc) have improved dramatically over the last few years, allowing users of even low-end TVs to zip through the YouTube app quickly. This doesn’t sound like a big deal but it can be very annoying for people to key in letters on an on-screen keyboard that is slow and laggy. Older systems were much more likely to interrupt videos with pauses for buffering or freeze entirely. We upgraded our TV recently and it feels great to be able to zip through videos now without any lag or delay.

Second, YouTube’s app itself has emphasized current content. This is important in that it allows a viewer to make YouTube viewing on the TV an everyday routine. Now, when you open YouTube, you can expect the latest world news, sports news, entertainment, etc. It’s no longer emphasizing old cat videos that got 100 million views. Instead it is emphasizing broad categories like News, Entertainment, Recommended, Sports, etc, each with their own current content. This has transformed YouTube from a primarily search-based service where you had to know what you were looking for, to a passive browsable service similar to linear television.

Third, user-generated content has exploded in quantity and, most importantly, quality. Everyone’s heard of YouTube stars that play video games, but there are now user-producers who are producing quality videos multiple times a week in all sorts of areas, including Travel, Comedy/Entertainment, Cooking, etc. The quality and editing of a YouTube streetfood video now is indistinguishable from a professionally-produced series on the Travel Channel. It’s really incredible.

Fourth, traditional cable has in many cases thrown in the towel and is now uploading their best content to YouTube, afraid of missing out on the younger audience that may have already cut the cord. For example, John Oliver’s program on HBO uploads the majority of his weekly show to YouTube. Many ESPN segments other than SportsCenter are uploaded. Most late night talk show hosts (Fallon, Colbert, Conan, etc) upload their main segments. And these are not user-generated videos They are official uploads by the producers.

I believe these factors are combining now to transform YouTube into a “platform” for passive, browsable TV viewing that is good enough now to truly take time from linear TV. While YouTube has been growing for many years, I believe this particular trend is just getting started as people shift their ingrained habits from turning on their go-to channel on linear TV to turning on YouTube every night.

Profitability of TV Viewing

This is a critical trend because linear TV advertising on a television screen is much more profitable than viewing on phones or computers. Google can include more advertising on the TV because users are more accustomed to watching the traditional 30-second ad on their TV than on their phone or computer (where an ad is either not shown at all or is shorter or skippable after 5 seconds). And it’s still just one ad rather than a full commercial break, so I don’t see users having any issue with it (compared to linear TV), particularly since they believe that a portion of the ad dollars are going directly to the content creator who posts their content on YouTube for people to view for free. Longer ad formats also allow advertisers to transfer their ad material directly from linear TV to YouTube without any changes to the length or content.

Structural Profitability Advantages

The YouTube model also is critically different from the owner/producer model of current linear TV and Netflix. These companies either purchase content directly or produce it themselves. In either case, content is essentially a fixed cost. If a show is a hit, great, you make a lot of money. If not, you lose money. In this respect, Netflix is essentially the same model as an HBO or Showtime. YouTube, by contrast, doesn’t purchase content (for the most part) and instead pays owners a portion of the funds generated. For YouTube, all of its content is profitable (ignoring data center costs). As revenues exceed data center costs and profits can be divided between YouTube and the content owners. There is massive operating leverage in the model.

In summary, the confluence of the above factors are allowing YouTube to become a “platform” for daily television viewing. This type of usage is nearly doubling year over year right now. Anecdotally (if it wasn’t already obvious) in my household YouTube has become the go-to nightly television option and we only use linear TV for sports or if there is a particular show that we want to record and watch later. It’s simply more fun to browse YouTube than it is to browse linear TV.

If YouTube can succeed in becoming a passive, browsable TV platform, I believe its structural profitability advantages and the underlying higher profitability of television ads will allow the company to exponentially increase profitability going forward. For these reasons I believe it is worth substantially more than Netflix and any traditional television companies. How much? It’s impossible to say, but I think a recent analyst estimate of $75 billion is way too low. Maybe $200 billion to $300 billion. A lot of this feels like stating the obvious, but sometimes significant trends can play out right in front of us. The market isn’t focused on YouTube because its results and trends are not immediately noticeable inside the larger Google business. But if these trends continue, YouTube could be the story of 2018.

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