Smart Move or Silly Money 2.0?

If YouTube becomes a $1.65 billion mistake, Google can afford it. That's why Old Media is wondering how to play this new game

by Tom Lowry and Robert D. Hof

Imagine being Philippe Dauman, who has been the chief executive of Viacom (VIA) for a mere six weeks. His boss, Chairman Sumner Redstone, booted his predecessor, Tom Freston, in large part because Freston was too slow to do a big Internet deal. The expectation is that Dauman, who ran his own investment firm, will be quicker to act. In turn, the assumption is that shareholders will applaud and the stock will soar.

But the view from Dauman's 52nd floor Times Square office is foggy at best. Only last summer, people were saying News Corp. (NWS) Chairman Rupert Murdoch had overpaid for the social-networking site MySpace.com. Now the $580 million price tag looks cheap. At least it does compared with the $1.65 billion Google (GOOG) is paying for YouTube, a 20-month-old video-sharing site with zero profits. Viacom's team held talks with YouTube founders, Chad Hurley and Steve Chen, too, but the negotiations never went anywhere.

Everyone from Time Warner (TWX) and Viacom to Yahoo! and Microsoft is under enormous pressure to acquire the next MySpace or YouTube. But amid steadily rising valuations, Old and New Media executives alike are afraid of overpaying and being punished by their shareholders. "We are seeing a valuation gap that sometimes doesn't make sense," says Wade Davis, Viacom's senior vice-president for mergers and acquisitions, who has overseen a handful of Web 2.0 deals whose prices collectively are well below what Google is paying for YouTube. Time Warner Chairman and CEO Richard Parsons, still dealing with the aftermath of the disastrous merger with AOL in 2001, has similar concerns. "We're interested in businesses that endure," he says. "You are not going to grow a business over the long term if it's being valued at 60 times earnings."

PROJECTING VALUE.

Paying up is less of a concern for a Google, of course. While Old Media continues to suffer from lagging stock prices and tepid advertising revenues, Google, Microsoft, and Yahoo (YHOO) have huge cash hoards, manageable debt, and, in the case of Google, a lofty stock price. Paying $1.65 billion for YouTube amounts to less than 2% of Google's $130 billion market cap—and the big bet on the video-sharing site could be as much about gut and ego as it is about hard-nosed business sense. And even if Yahoo decides to spend $1 billion to acquire Facebook, the popular social-networking site for college students, that isn't likely to break its bank, either.

Nonetheless, some analysts see a lot of froth in the market, and the risk remains that even highfliers like MySpace and YouTube could flame out if their fickle, youthful audiences decide to move on. "Every monkey with a video-sharing site is going out there and asking for double their previous valuation," says Paul Kedrosky, a venture investor with Canadian VC firm Ventures West Management.

What really has the media world agog is the assertion by RBC Capital Markets analyst Jordan Rohan that MySpace could be worth $15 billion in three years—or nearly 30 times what News Corp. paid for it. Rohan says the social-networking site's "trajectory for profitability" is every bit as steep as Google's. But his reasoning is based largely on the fact that Google has agreed to pay MySpace $900 million over three and a half years in exchange for being its search provider.

Critics have pounced on Rohan. One is Robert Holthausen, a finance professor at the Wharton School at the University of Pennsylvania.