A YouTube spinoff would be a fantastic addition to Alphabet’s already attractive stock, as the platform is currently undervalued.
Back in May, I wrote about Alphabet (NASDAQ:GOOG) and three reasons why Alphabet stock is a long-term buy. One reason to be excited about Alphabet stock over the long term is the growing expectation that Alphabet will spin off its hugely successful video platform, YouTube.
Months have passed, and little has changed, including the stock price, which has not moved at all in the 61 days since then.
There isn’t much YouTube news ahead of Alphabet’s Q2 2024 earnings report, which will be released after the market closes on July 23rd.
But YouTube Music has introduced a new Sound Search feature that lets users hum a song to find it across a catalogue of over 100 million songs, similar to Apple’s Shazam.
The company announced that it is experimenting with AI-generated conversational radio, where users can describe what they want to hear and YouTube’s AI can find examples that fit that description.
With European regulators pushing for Alphabet to be broken up, here are three reasons why a YouTube spinoff would make sense sooner rather than later.
YouTube will be attractive to investors
In my May article on Alphabet, I mentioned that Needham analyst Laura Needham estimated YouTube’s market cap at $423 billion. In early July, she offered more details about YouTube’s valuation and regulators.
“We believe that [Alphabet] “Alphabet is more valuable broken up than it is together,” Martin concluded, “so we welcome regulators’ attempts to break up the company,” Barron’s reported on July 5.
The analyst believes that if YouTube were to separate from Alphabet, its value would be 50% higher than its value within the tech giant. She estimates that even a partial spinoff would add 8% to the valuation of Alphabet shares, with a price target of $210, well above where the company is currently trading.
Based on Needham’s $423 billion valuation, it would be the ninth-largest stock by market capitalization on the Nasdaq 100 index.
And even if YouTube were to be completely separated from Alphabet, its former parent would still be valued at nearly $2 billion and remain sixth on the Nasdaq 100 index.
YouTube revenue continues to grow
Martin estimates that YouTube’s ad revenue will be $31.5 billion in 2023 and will grow 13% to $35.5 billion in 2024.
Meta Platforms (NASDAQ:META) has advertising revenues of $131.6 billion excluding currency in 2023. Total revenues excluding currency are $134.5 billion, valuing it at 16.4 times sales. If YouTube gets the same P/S ratio, its market cap would be $574 billion, $151 billion higher than Martin’s estimate.
As Barron’s points out, YouTube is the top streaming platform for watch time in 2023, accounting for 9% of total hours watched, beating Netflix (NASDAQ:NFLX) by 50 basis points. More importantly, its $574 billion valuation may also be lower, as YouTube’s ad rates per thousand impressions are 30-50% higher than Facebook and Instagram.
Martin values YouTube at at least $355 billion from advertising revenue, but could be as much as $625 billion. Add in the $175 billion in advertising revenue from its subscription businesses, which include YouTube TV and YouTube Music, and you get a value of $535 billion, $112 billion higher than his valuation in May.
Unfortunately, Alphabet’s current enterprise value is 6.3 times sales, or $350 million, about $200 billion less.
Summary of Alphabet Stocks
One word that gets thrown around a lot when discussing spinoffs is “focus” – the idea of adding by taking less. If Alphabet were to split into three businesses, Google Cloud, Google Search, and YouTube, capital allocation and growth efforts to each business would be more focused as three independent companies.
The downside to this is that if one or more sectors suffers a downturn or faces unexpected headwinds, the three businesses won’t be able to rely on each other – which is the benefit of having multiple revenue streams.
The benefit of this move is that quarterly financial reports and operational discussions will be reported separately, allowing investors to better evaluate each business. As Martin points out, YouTube’s undervaluation is wasting money.
But the reality is that all three of these businesses are likely missing out on profits, which is why investors often use the sum-of-the-parts valuation method for complex businesses.
I think there’s no question that Alphabet would add value to shareholders by spinning off some or all of YouTube, and doing so sooner rather than later would put an end to the regulatory breakup debate.
Alphabet stock remains a buy.
As of the date of publication, Will Ashworth did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the author in accordance with InvestorPlace.com’s publishing guidelines.
On the date of publication, the editor in charge did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has been writing full-time about investing since 2008. His writing has appeared in InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and other publications in the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.