Alternative Route
It's 2006. Larry Page is brushing his teeth when he hears a Google Talk chime. It's Sergey.
"Watch this now!" Brin goads Page to watch "Evolution of Dance," one of the early YouTube posts to catch viral fire.
Page chuckles at the video. But when he sees the views — going up every moment — his jaw drops.
"We need to own YouTube," he taps into his C64 and replies.
Lamplighter's guessing that's how it went, anyway.
The search for product
Google went ahead and bought YouTube for $1.65 billion. On the one hand, people were going to view YouTube videos in 2006 about as much as they looked at the entire internet in 2000. And this was less than two years after the site launched. That's pretty appealing to Google, who sells views to advertisers.
On the other hand, YouTube wasn't even old enough to remember Brittany Spears' wedding to K-Fed in 2004. It did a sheepish $15 million in revenue in all of 2006. Google paid more than 100 times YouTube's revenue. That's not a deal that works well on paper.
How did that turn out?
18 years later, YouTube posted revenue of $34 billion. It's likely worth $200 billion, maybe $400 billion. It's hard to know what Google has spent on YouTube since the deal, but, whatever the figure, it seems that Larry and Sergey feel pretty good about how it's played out.
Rules of the road
That deal broke lots of rules for good M&A. It was an all-stock deal. Google paid a price completely detached from YouTube's financial results. YouTube didn't fit neatly into Google's primary business of searching other people's websites. It’s still a separate business. These are all qualities that fail M&A "best practices."
Even Google later admitted that it might have overpaid.
What made it work?
Besides a little good luck and pretty-good management, Google had customers — the world's advertisers — and YouTube had product — eyeballs. Google plugged its advertising machine into YouTube's viral production line, and it worked magic.
But what if YouTube hadn't tucked into Google or Microsoft or Yahoo or any of its other suitors? Was there an alternative route it could have taken? What if, instead, it had tried the climb up Silicon Valley's ranks on its own?
Fork in the road
YouTube could have gone out and started buying AdTech companies that had customers to pay for all its viewers and begun delivering more and better ads. This strategy works too. Microsoft purchased LinkedIn to gain access to its 433 million members/potential customers. You can think of bank mergers as also following that has product/acquires customers path. Brad Jacobs, a deal enthusiast, very helpfully wrote a book — "How to Make a Few Billion Dollars" — detailing his M&A exploits at XPO, a logistics outfit he ran that also acquired a lot of customers through deals.
Final destination
Lamplighter wouldn’t recommend breaking the rules for good M&A. They’re there because they work. Most of the time.
But. If a company is going to go out and do a deal that defies the excel model, checking whether it falls into a “has customers/acquiring product” or “has product/acquiring customers” bucket can hint at whether it has a chance to work.
Mismatches between companies with great products and companies with strong customer books happen often. Maybe the founder is only a great product guy or a great saleswoman, but not both. M&A is an obvious tool to fix this. If you mash together a company with a great product and a company with customers, you get the next Google, maybe.
Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.