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Last night, Google (GOOG, $426.65, -2.35) did what just days ago tech industry exec Mark Cuban said only a moron would do: it bought online video site YouTube.com. In doing so, Google also departed from its usual practice of buying small companies (not market dominating ones), though it could be argued that YouTube is still a startup. More drastically, Google broke from its penchant of buying technology as opposed to traffic. Finally, the cash-laden company surprised the market by using stock to pay $1.7 billion for YouTube. The matter of how it paid for YouTube isn't nearly as important as why it bought the company and what that could mean for Google and its chief rivals.
Google's motive was two-pronged. First, this is an admission that its own online video effort has been a dud -- though it's strange that YouTube will continue to be operated separately. Second, Google bought YouTube so that neither Microsoft (MSFT, $27.69, -0.03) nor Yahoo (YHOO, $24.47, -0.56) could. On those counts, the deal is a win, as Google's own video offerings just got stronger, while those of its rivals grew relatively weaker. Google talked enthusiastically about the social networking potential of YouTube, but Google's own development and integration efforts outside of search have been weak, and we don't expect much on that front.
The deal is going to pose a challenge to Google in two important ways. First, the company has inherited a legacy of copyright infringement. With plenty of cash, those infringed upon now have a viable target to sue. This is why Cuban said buying YouTube was a stupid idea. Beyond the cash involved, however, there's also the matter of securing content going forward. Analysts like the opportunity in professionally made content as opposed to user-generated, and in the run-up to the deal, YouTube did ink some impressive media deals with Universal Music Group, Sony BMG, and CBS (CBS, $28.37, -0.19). These come on top of deals with NBC Universal and Warner Music Group (WMG, $26.94, +0.17). In doing so, however, Google and YouTube will have to be careful not to go too commercial. While YouTube's demographics are changing, with the average age of users rising, at this point, the users most likely to watch a TV show at their desks are the ones who go to YouTube for user-generated content. Social networking sites that have fiddled with their original ideas too much quickly fizzle.
If Google can strike the right balance, YouTube certainly gives the company a heavily trafficked new place to put its search box, and a platform on which to refine its video search technology. Additionally, it gives Google a good roster of content partners and the chance to build a video advertising business -- though notably Google will have to prove that it can succeed beyond text searches.
For aspiring search-competitor Microsoft, this deal obviously makes Google tougher to compete against. Still, at MSN, Microsoft has built one of the most popular video sites online, mainly with exclusive live Web broadcasts and through relationships with premium content providers. The company definitely has the resources to continue to grow this business considerably.
As an Internet pure play, Yahoo has more to lose in this battle, which was reflected in the market today, where the stock gave up -2%. Certainly the company is no slouch in video, but Yahoo is going to have to continue to offer more content, better search functions, and better integration to continue to hold its own against the bulked-up Google.
The migration to online video doesn't present a viable threat to cable TV revenue yet, but longer term, it could present challenges to companies like Comcast (CMCSA, $37.64, -0.02). At present, cable seems to be in the driver's seat when it comes to online video. For starters, cable companies, like DSL providers, provide the pipes to deliver video online. High-speed Internet service has been a huge growth driver for Comcast.
At the same time, cable has arguably been a front-runner in alternative distribution with its on-demand services. These services continue to grow rapidly at Comcast thanks to movies and a growing catalogue of TV programs with many of the same partners YouTube has embraced. Meanwhile, the company has quietly grown its own online video distribution business via both the hugely popular Comcast.net website and its production system known as "thePlatform." We noted last month that there is increasing industry speculation that Comcast is going to launch its own video and music download store. Some of those rumors have since included the suggestion that it will debut this month, and will feature integration with both PCs and portable devices, as well as with DVRs. One of the strengths of this platform would be Comcast's ability to ensure a quality download because, if bandwidth ever became an issue, the company could prioritize bandwidth allocations. The so-called "Net Neut rality" issue is a touchy subject, but in this case, it is an example of the advantage Comcast could have over content-only companies.
Editor's Take: In the wake of the YouTube deal, there's speculation that other acquisitions of startups are to follow. Perhaps. But for both Microsoft and Yahoo, the acquisition route should focus on technology rather than traffic, including technology that can improve video search results. Even better than moderate acquisitions of this sort would be more partnership agreements and/or a big deal. With Yahoo sinking to a new 52-week low today, the issue of a takeover has to be mentioned. With a market cap of about $34 billion, Yahoo could be had relatively cheaply, with Microsoft the most logical buyer -- in spite of its aversion to deals that size. Finally, we have to throw this out there: with Net Neutrality likely to become a bigger issue, what about Comcast buying Yahoo? The market hated the cable company's bid for Walt Disney (DIS, $31.25, -0.14) a couple of years ago, but Yahoo and Comcast are arguably far more complementary in terms of their cont ent and distribution assets, and in their relationships with advertisers. Undervalued at present levels, Yahoo could make Comcast into a powerhouse ad platform. We'll dig into this idea a little more. Watch for more, as well as an update on our Target for Comcast.
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