How Much is YouTube Worth? $170bn in 2020
November 22, 2020 | 15 minute read
How much is YouTube worth today?
Google acquired YouTube for US$1.6 billion back in 2006. We estimate YouTube to be worth up to US$170 billion in 2020, delivering Google a +100x return in under 15 years.
This article will cover in-depth how we arrive at this valuation and the steps you can follow to build your own model for YouTube and to value any technology company:
- 5 key questions to understand YouTube’s business model
- Building a YouTube financial forecast model
- Preparing a final YouTube valuation
Skip to the following links for a valuation checklist and complete financial model:
To reach a valuation for YouTube, we must firstly answer 5 questions about the business:
- Industry: What industry does it compete in?
- Customer: Who are its customers and how does it deliver them value?
- Revenue: What is its revenue model and key drivers?
- Costs: What are its major costs and how are they managed?
- Growth: What is the growth thesis?
1. What industry does YouTube compete in?
YouTube is the world’s largest online video service and competes for user viewership in order to compete for digital advertising spend from businesses. YouTube’s parent is Google/ Alphabet and operates globally except China where Google is banned.
Global ad spend (ex China) is over half a trillion dollars annually, of which half is spent on digital (web and mobile). The lion’s share of this is dominated by Google and Facebook which capture over 80% of digital ad spend.
Splitting up Google and Facebook’s major ad platforms we reveal YouTube is the 5th largest digital ad platform with 6% share, behind Google Search, Facebook, Google Display and Instagram.
Future growth of the digital ad market is any oracle’s guess. But if we assume digital remains a dominant advertising medium industry, then digital spend could reach over half a trillion by 2030 (assumes 7% annual growth).
When looking at the industry a company operates in, focus on how the company generates revenue and compare against competitors and alternative mediums. Research industry statistics and competitor annual reports to get a rough estimate of how large the current industry is.
2. Who are YouTube’s customers and how do they deliver them value?
YouTube is an online video platform that allows content creators (individuals and businesses) to publish videos for users to watch. YouTube sells ads to businesses placed within video content and shares the revenue with publishers.
YouTube delivers value to 3 key stakeholders:
- Creators: monetize their video content on the platform with the widest reach. Allows creators to focus on producing quality content and outsource hosting and marketing costs to YouTube
- Users: free, targeted and relevant video content and entertainment (for better or worse)
- Advertisers: brand impressions and targeted reach across a global audience
YouTube ultimately competes for global viewership and monetizes this by selling ads to businesses. YouTube has over 2 billion monthly active users and is the second largest social media platform in the world. The chart below compares the monthly active users across major ad supported social media platforms and video platforms:
Whilst each player competes for viewership, their target audience and monetization models differ:
- Facebook, Snapchat, Instagram and Twitter sell ads placed in a user’s social media feed of images, video, news, articles
- Netflix sells subscription services to users for its original and purchased content
- TikTok is early in its monetization strategy
When understanding how a company generates revenue, ask yourself: Who is the customer and why would they pay for the offering? For technology platform companies, understand the ecosystem of stakeholders and the benefit each of them receive from using the platform.
3. What is YouTube’s revenue model and key drivers?
YouTube has two primary revenue streams:
- Ad sales (90% revenue): YouTube sells targeted ads within video content across its 2 billion monthly active users. It shares ad revenue with content publishers via a 45/55 split in favour of publishers; and
- Subscription (10% revenue): YouTube premium offers an ad free video experience and music service offered at ~$10 per month. There are currently 20 million premium subscribers representing ~1% of YouTube’s total monthly active user base
YouTube’s key revenue driver is its ability to monetize its monthly active user base. We can assess its performance vs peers by comparing the average annual ad spend generated by each provider divided by its monthly active user base.
Facebook currently generates 2x higher ad revenue per active user than YouTube across both Facebook and Instagram platforms. This could be explained by Facebook’s greater variety of ad formats and granular audience targeting (interests, age, behaviour, lookalike audience) and being further along its journey of ad monetization.
The biggest driver of revenue for YouTube will likely be its ability to drive higher ad spend to its already large audience via product innovation (e.g. new ad formats, improved targeting) rather than growing its audience. YouTube is also earlier in its monetization strategy and has also invested significant resources to clean up the quality of content published.
The key to understanding any revenue model is to identify the key revenue drivers: 1) volume (e.g. customers, users, businesses), 2) pricing (ARPU, new products, upsell) and 3) churn (% customers leaving each month, non-renewals). Try and understand the narrative of how the company can influence these drivers.
4. What are YouTube’s biggest cost drivers?
YouTube’s major costs can be separated across 3 categories:
- Cost of Revenue: variable costs associated with delivery of services and revenue. Includes ad share revenue paid to creators and data-centre operation and hosting costs;
- Operating Costs: largely staff and support related costs to drive platform and product development (R&D), revenue growth and creator support (Sales & Marketing), content moderation, finance, admin (General & Admin); and
- Capex & Acquisitions: investments in data-centre infrastructure, acquisitions of businesses and supporting tech. These are cash outflows not captured in the income statement
Cost of Revenue YouTube’s largest cost base is the revenue it shares with content publishers. It splits ad and subscription revenue attached to content viewership in the ratio 45/ 55% in the favour of publishers.
YouTube’s other major variable costs are the delivery and data-centre operation costs for the 500 hours of video content that gets uploaded every minute. These costs largely include depreciation charges following major upfront capex investments in data-centres. We estimate 7% in line with Alphabet’s overall depreciation charge as % of revenue.
Operating Costs Alphabet does not publicly disclose YouTube’s other operating expenses so we will need to estimate.
YouTube’s major fixed costs are its operating costs which are largely staff related and associated with sales and marketing, supporting creators, research & development (software and product roles), content moderation (outsourced contractors), finance, admin and support.
We can estimate YouTube’s opex margins by comparing against peers. Netflix has a total opex/ revenue of 20% and Facebook at ~35-45%. We can estimate that YouTube may currently operate within the range at 35% opex/ revenue. We can assume given scale benefits that this will lower over time in line with Netflix at 20% opex as % of revenue.
This analysis highlights that YouTube’s profitability is lower than other social media platforms and Google’s other ad businesses. This is largely due to YouTube’s reliance on ad sharing with content publishers.
Capex & Acquisitions Alphabet does not separate YouTube’s cashflow financials so we must estimate capex figures.
In our methodology, depreciation is already accounted for in the operating expenses hence we must estimate the incremental net capital expenditure (e.g. capex less depreciation) in order to estimate the total cash outflows associated with investment in infrastructure.
We will adopt the Godfather of Valuation’s (Aswath Damodaran) approach of using the sales to capital ratio to estimate the required net capex to support revenue growth. This is calculated as the net change in revenue divided by the net capex of each year.
Alphabet has an average sales to capital ratio of 1.9x (annual change in revenue divided by change in invested capital (debt + equity less cash)). This implies that for every $100 of incremental revenue Alphabet generates each year it reinvests $50 as capital to support growth.
When estimating costs, identify the major drivers across cost of revenue, operating costs and capex costs. Go through annual financial reports to identify the major line items and review notes to understand what is included and not included and understand the main drivers.
5. What is the growth thesis for YouTube?
Based on our above analysis and understanding we can base our growth thesis for YouTube on two key drivers: ad monetization and stable user growth.
Ad Monetization YouTube is early in its monetization strategy and has largely relied on ad revenue from high quality in-video ad formats driven by impressions. It has begun to experiment with new formats including direct response display ads within homepage recommendation feeds and direct text search ads. These new formats support greater ability to sell more ads to its user base.
We can estimate that YouTube over the next 10 years will increase its ad monetization from $8 ARPU to $23 ARPU in line with Facebook currently.
Stable User Growth YouTube shares a majority of ad revenue to content publishers which is negative for gross profit margins but positive for supporting high quality content creation. This will likely attract amateur and professional content publishers to continue choosing YouTube as their platform of choice for social media monetization.
We will conservatively estimate that user growth while mature, will still grow from 2 to 3 billion monthly active users over the next decade. Similarly, we assume a portion of active users will prefer an ad-free experience and so we forecast YouTube premium subs to increase from 20 to 70 million active users over the same period. These are conservative forecasts and take into consideration an element of heightened competition from incumbents and newcomers e.g. Instagram, TikTok, ...the next thing.
With our supporting growth thesis for YouTube established, it is time to forecast the future generated cash flows over the next 10+ years.
Revenue forecasts The key revenue drivers are Monthly Active Users, ARPU, Premium Subs and Pricing. We then cross check this against our estimates for the global digital ad spend market.
YouTube Forecast Revenue Model
Our thesis implies that over the next decade, YouTube will grow from a ~$20bn annual revenue business with 6% share of the digital ad spend, to become a $83bn business with the majority of revenue dominated by ad spend and a doubling of its share of global digital ad spend (ex China) to 13%.
Cost and Profitability forecasts Following our revenue forecasts we must estimate operating costs and reinvestment rates to arrive to our forecast free cash flow figure
YouTube Forecast Operating Cost and Cash Flow Model
- Cost of revenue: we assume YouTube will remain a platform for high quality video content published by creators and will continue to pay out majority of ad revenue to creators. This implies gross profit margins will remain largely unchanged at ~37%
- Operating costs: assumed to fall over time from 35% to 20% of revenues as platform ad monetization scales
- Taxes: assume an effective blended US and global tax rate of 21%
- Reinvestment: sales to capital ratio of 1.9x in line with Alphabet which implies YouTube reinvests 50% of revenue growth back into the business
When forecasting revenues, costs and cashflows follow 3 key steps: 1) identify the key drivers for each component; 2) formulate a thesis that supports each driver; and 3) cross check against industry assumptions and peer metrics.
Putting it all Together - What is the Valuation for YouTube? To complete our valuation we must estimate the terminal value at the end of our 10 year forecast period. The terminal value represents the present value of the company’s cash flows at that time assuming the cash flows of the firm will grow at a constant rate forever.
We need two final assumptions to arrive at our terminal value:
- Long term growth rate: this is the constant rate we expect YouTube to grow in perpetuity beyond year 10. We assume this to be 3.5% (higher than long term US GDP but lower than the long term forecast growth in digital ad spend)
- Discount rate: this is the rate we will discount future cash flows to arrive at our present value. We assume this to be 7% which is low by historical standards, however valid in a post pandemic world where interest rates globally are expected to remain close to zero for the foreseeable future. See my previous post to understand the principles of a discount rate when valuing businesses.
With these two assumptions we can arrive at our terminal value. The formula for terminal value which applies the perpetual growth model is beyond the scope of this article but in essence calculates the present value of an annuity (see this article for the formula proof).
YouTube Summary Valuation Finally, we can estimate our terminal value and discount it and the sum of our 10 year forecast cash flows to arrive at our valuation for YouTube which equates to US$168 billion. Not bad for a business Google acquired for US$1.6 billion.
YouTube parent Alphabet over the course of 2020 traded at an average enterprise valuation of $900 billion which implies YouTube could represent up to 1/5 of the trading valuation of Alphabet.
Compare our $168 billion valuation for YouTube with the average 2020 trading market cap of the world's dominant video and entertainment giants:
- Netflix: $175 billion; and
- Walt Disney Co: $213 billion;
A caveat, our valuation is a summary interpretation based on the assumptions we have made. Changes to our assumptions can have a wide impact on the valuation. For example there could be significant upside to earnings if YouTube is able to monetize ad spend via direct search and display ads vs in-video ads (given higher margin earnings), but similarly it could face significant downward pressure if content moderation costs escalate in response to abuse of the platform.
Valuation is more art and science. It is more important to understand the key drivers of a business and adjust your model for changes to these assumptions. A valuation should never remain static, but rather change as business conditions or your thesis adjusts.
Here is a helpful checklist you can follow when approaching to value a company yourself:
- Questions: write out all the key questions you would like answered across the industry, customer, revenue and cost model and growth thesis.
- Research: start by reading annual reports of the company and competitors to answer your questions. Read the description of the business segments and revenue. Identify the key drivers and any missing information that will need to estimate. Read investor presentations for operating metrics and clues that may not be included in annual reports. Avoid investor relations jargon and focus on how the business makes money.
- Build financial model: Start preparing your revenue, cost and cash flow model. Each company is different and each model will be too. Creating a financial model (even in a crude form) will help you identify which areas of the business matter most.
- Experience the offering: once you have identified the key drivers, research the company’s product or service offering. Try it yourself, watch demos, read reviews. Form your own view. Financials are a reflection of the willingness of customers to purchase the offering of the company.
- Growth thesis: Form a thesis and story as to what will drive the revenues and costs of the business going forward (either up or down). Sense check this against industry and competitor/ peer metrics. Incorporate your thesis as the driver of your financial forecasts.
- Valuation: Finally, estimate the terminal value and discount your forecast cash flows to a present value. Adjust inputs based on your thesis to identify how sensitive your valuation is to key assumptions.
Click below to access the complete summary financial forecast and valuation model for YouTube covered in this article. You may duplicate a copy and adjust the inputs yourself.
My valuation estimate for the entire Alphabet business is US$1.8 trillion. Below is a Sum Of The Parts breakdown of each of the businesses following the same approach as we have done for YouTube.
- Search & Display: $1.2 trillion
- G-Suite/ Workspace: $210 billion
- YouTube: $168 billion
- Google Cloud Platform: $158 billion
- Net Cash: $112 billion