Send As SMS

Friday, November 10, 2006

Valuing YouTube, back of the envelope

As a result of discussions on related subjects with various friends recently, I've just done some rough calculations, with an astonishing (or not...) result: Google's purchase price is within reason.

  • For simplicity, treat Google as a proxy for all of YouTube's customers so YouTube sells all of its inventory to Google with a standard 4-ads-per-page setup (I'm only counting video viewing pages, although this is most of them on YouTube).
  • Each video is no more than 10MB in size (YouTube rules).
  • YouTube buys its bandwidth for an average of $0.07/GB (a somewhat plausible figure that I've heard bandied about for buying at the volumes that YouTube uses).
  • Ad clickthroughs occur, on average, once per thousand impressions (informed guess).
  • 100 000 000 video downloads per day (BBC).
  • Clickthroughs earn a dollar each (arbitrary guess, but I suspect that it's conservative).
  • 5% is a reasonable economic discounting rate (close to current bankrates and inflation).
  • 1000MB/10MB tells us 100 downloads per GB,
  • with 4 ad impressions per video download, this tells us 400 ad impressions per GB,
  • with a 1/1000 clickthrough rate, this tells us 0.4 clickthroughs per GB,
  • with $1 revenue per clickthrough, this tells us $0.40 revenue per GB, against a bandwidth cost of $0.07 for a GP of $0.33/ GB. (That's a staggering 472% markup or, more usefully, an 82.5% gross margin.)

So, what is this in dollars?
  • 100 000 000 downloads per day / 100 downloads per GB tells us 1 000 000 GB per day (a quadrillion bytes / day, or an average of 93Gb/s),
  • with a GP of $0.33 per GB, this tells us $330 000 GP per day (note that, in my simplified model, this means that Google was paying YouTube around $400 000 per day prior to the acquisition; no wonder they were interested in acquiring!)
  • This is about $120 450 000 per year,
  • which, when divided by 5%, gives us a net present value of $2.409 billion.
If Google insists upon a discount for investor risk of about a third, this puts offer price at about $1.6 billion, which is almost exactly what did happen.

I didn't make these numbers up to get this result, I simply made obvious guesses and happened to end up landing within 3% of the actual sale price. Lest anyone assume I am claiming a particular expertise here, most of the numbers really are guesses and I don't expect that any of them are accurate to within 3%. Consequently the result was just a fluke, but the reality is somewhere nearby and it at least suggests that Google's purchase price wasn't all that crazy.

About the assumptions:
  • YouTube was/is presumably selling some inventory to higher paying advertisers (than Google), typically when someone was mounting a huge campaign (as I write, Virgin appears to have bought almost all of the current inventory, at least for UK users). It is also likely that, in some cases, Google wasn't willing to buy, or was bidding lower so some other advertising network was able to place ads. It is even possible that some views attracted no pay-per-click advertising at all. I suspect that "Google as proxy" is actually pretty close to the mark.
  • The average size for videos will actually be smaller than 10MB, which means that these figures underestimate profits.
  • The bandwidth figure is very difficult to substantiate as (a) it's commercially sensitive and (b) they'll be buying bandwidth in many different ways and many different places from many different organisations. Fortunately, on these figures, YouTube remains [somewhat] profitable all the way up to a little over five times this estimate, so unless I'm a long way out, there's some real profit here.
  • The 1000 clickthroughs per impression comes from an industry insider, and not just an offhand "oh, it's about 1000:1", but actual figures from a day's operations, which came out at just above that figure.
  • The $1/clickthrough stems from my own experience. I have no idea what the whole-of-market figures are (but as for the bandwidth figures, note that the profit margin is so huge that this can drop by more than 75% and still leave a profit margin).
  • The 5% discounting rate is right on the Bank of England's rate, marginally under the US Fed rate and marginally above the ECB rate. I'd say it's about right, but if you want to use the US Fed rate (5.25%), then this will take about 5% off the valuation.
  • The "discount for investor risk" is pulled out of the air; I really don't know what discount Google would seek, particularly given the need to placate the RIAA, but 1/3 seems like a reasonable starting point.