The market saw a recent rally in the NASDAQ 100, driven largely by earnings at Microsoft (MSFT) and Alphabet (the company formerly known as Google (GOOG)).
GOOG’s new CFO, Ruth Porat, who took her position in March, is helping the company communicate better with Wall Street. Before her arrival, GOOG had started the process of restructuring into a holding company and separating different operations into distinct, separately reporting units. When GOOG makes its next annual report, investors will get a clear view of how much the company is spending on its “moon shot” projects, for example -- as well as a clearer view of the relative performance of its different advertising segments.
Not yet, however. The quarter that was reported last week was the last one in which the internet giant will report in the old way. The company beat on revenue and earnings, and a modest $5 billion stock buyback was greeted enthusiastically by investors. Porat noted that YouTube was providing a “strong contribution” to revenue growth. We will be watching GOOG’s next earnings release closely for exactly this reason: we concur with analysts who view video as the biggest current driver of online ad growth, and we want to see hard numbers showing how YouTube is stacking up.
YouTube and Cord Cutting
GOOG’s earnings report came a day after a significant YouTube announcement: the imminent launch of a product called YouTube Red. The service will cost $10 per month ($13 for Apple users because of extra fees) and will give users access to YouTube without advertising, allow YouTube to play in the background on a device while other apps are running, and save videos for offline play.
This may have been YouTube’s ultimate purpose from the time GOOG bought the company in 2006 for $1.65 billion. At the time, critics thought the purchase was too expensive, but it may turn out to be a lasting pillar of GOOG’s revenue growth.
At first, users uploaded often copyrighted material to YouTube, and when presented with notifications from the copyright holders, GOOG would take offending material down. Then GOOG introduced advertising, inducing the copyright holders to allow their material to remain available in exchange for a portion of the advertising revenues. In this way YouTube became a large repository of music and video -- and eventually, rather than requesting takedowns, copyright holders set up their own YouTube channels and uploaded content to the site themselves. For free users willing to tolerate the advertisements, YouTube is a common destination for streaming music. In the end, it wasn’t legal sanctions that sidelined music piracy -- it was the convenience of services like YouTube, which found a way to monetize that convenience.
Now, with YouTube Red, the circle has been closed. After building its content repository and status, and making YouTube a default video and music streaming destination for many users, GOOG now has the leverage with content providers to get them to accept the subscription model. “Early next year,” the company says, YouTube Red will be also be providing exclusive original content available only to subscribers. Other YouTube Red services will be rolling out, including a music app to allow users to organize, access, and discover new music.
We are not sure exactly what lies ahead for the service, but we view the arrival of a premium streaming service from GOOG as another blow struck in favor of the “cord cutters” -- those jettisoning their expensive cable subscriptions that are often filled with bloat they never watch but need to purchase as part of a package deal. GOOG’s service will be one more inexorable force pushing in that direction. To follow through, GOOG will need to leverage its position and acquire content that will help it compete with other streaming services such as Netflix (NFLX) and Amazon (AMZN).
Investment implications: Alphabet’s (GOOG) ten-year odyssey with YouTube has built the site from an early investment of questionable value into a potential pillar of GOOG’s future revenue growth. In GOOG’s next earnings report, we will get detailed results on different advertising segments, including YouTube, and the company is also launching a premium ad-free subscription service in its bid to capture revenue from “cord cutters” who are relinquishing their cable TV packages.
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