#109: On Normative Economics & Google
A Working Paper
When Google kicked AppNexus and other DSPs out of YouTube in 2014, we immediately lost share because they could say "we have supply that they don't." I know the YouTube + DV360 bundling was not in the US ad tech antitrust case, but hard to imagine this isn't going to be addressed. If DV360 loses access, or YouTube opens up to TTD... look out.
— Brian O’Kelley, LinkedIn, February 2024
How wrong could we be?
Everything about this working paper is an experiment. It’s an experiment in the sense that we ask a hypothetical question that leads to other interesting questions. It’s also an experiment in how to value adtech companies with sparse information using the key value drivers of discounted economic profit modeling. Lastly, this working paper is an experiment in which our Quo Vadis community can participate with feedback, pushback, new information, and diverse perspectives with a general curiosity for solving puzzles.
Inspiration
The inspiration for this working paper titled, “On Normative Economics and Google's Game Moves” came from the CEO of an adtech company who read Quo Vadis’ October 16, 2024 post — “Open Web Market Sizing” — and asked what would happen to media flows and open web growth if Google opened YouTube’s ad inventory to external DSPs?
In the Open Web Market Sizing post, we explored where media money is increasingly flowing and its impact on the "Open Web" portion of the market (8% of global media spend).
What started as a simple hypothetical and fun conversation quickly evolved into a broader exploration of the potential impact on YouTube as well as Google’s display advertising assets, the DOJ game, and the entire adtech ecosystem as a whole. For instance:
What are each of Google’s key display advertising assets (AdX, Google Ad Manager as a publisher ad server, and DV360) worth to an outside buyer?
What are they worth to Google and what is the difference?
And how might opening YouTube’s ad inventory to external DSPs impact Google’s revenue growth and alter the competitive landscape?
Working Paper
The result is a working paper for community review titled, “On Normative Economics and Google's Game Moves.”
The paper is about two intertwined subjects. One is real and the other is not real. First the real subject. In the Department of Justice’s (DOJ) antitrust case against Google’s display advertising business (commonly referred to as “Network Revenue” in Google’s financial filings), the DOJ’s case alleges that Google has (or had) a monopoly position across the display advertising market (banner and video ads on websites). During the trial, several representatives from various adtech companies testified against Google. In that sense, one can characterize the case as a game made of two sides with three players. Google is on one side and the other is an ad hoc coalition between the DOJ and the adtech community.
Several compelling questions have been raised as new information on Google’s Network revenue was brought to light in the trial, for instance:
If Google were to break up the three main business components of its Network business (Publisher Ad Server, AdX supply-side platform, and DV360 demand-side platform), what would each one be worth to an outside buyer?
That leads to a second good question:
If Google were to break up the three main business components of its Network business, what is each one worth to Google and what is the difference from the value an outside buyer would pay for these businesses?
Yet a third interesting question might be:
If the value that Google places on its Network business (which is presumably more than an outside buyer’s valuation) is immaterial in the context of Google’s overall valuation ($2.1 trillion), then why does Google keep playing in the adtech game given all the headaches against a backdrop of a mature low-growth and low-margin open web display advertising market?
The unreal subject (or not)
The unreal, yet plausible, subject is how Google can use YouTube as a game move to solve three problems in one go. In all the fuss and trade press drama about the DOJ case, what's not discussed is YouTube’s large CTV market share. Although purely hypothetical, what if the DOJ concluded that winning the display advertising case is a low and decreasing probability outcome, and instead looked at YouTube for something new to do?
And what if, as a pre-emptive game move response, Google played the ultimate Sun Tzu move and opened up YouTube ad inventory buying to external DSPs which in turn opens new opportunities for 3rd party verification and measurement providers? Doing so solves three problems: 1) YouTube revenue growth gets a boost; 2) the adtech community flips from foe to friend; and 3) current DOJ antitrust risk is diminished and future risk is greatly reduced.
What is it worth to Google to get carried off the field of play on the shoulders of the adtech community like a champion vs. all the friction it faces today?
What the numbers say
On a sum-of-parts discounted economic profit basis, our fair market value for Google’s Network (Publisher Ad Server, AdX supply-side platform, and DV360 demand-side platform) businesses is worth $13 billion to an outside buyer.
When Google’s publisher ad server is stripped away from GAM as a stand-alone business, it’s worth $2.1 billion to an outside buyer.
Google’s AdX SSP and ad exchange, which include acquired assets from DoubleClick, AdMeld, and AdMob, as well as, AdSense and the interconnected exchange elements inside GAM, is worth $6.3 billion to an outside buyer.
DV360, Google's demand-side platform (DSP) is worth $4.7 billion to an outside buyer.
However, Google would very likely value its Network businesses more than outside buyers given its ability to extract higher take rates into net revenue at a lower marginal cost (e.g. lower internal cloud costs) as well as its ability to squeeze more operating margin out of each business given its scale and back office fixed cost advantages.
Relatively is everything
With Google as the operator of the Network business, the contribution to overall economic profit is just $1.5 billion on an overall business (dominated by search) that generated $65 billion in economic profit in 2024 (e.g. pure free cash flow).
And if there is one thing investors know about Google, it has a great track record of allocating cash into new invested capital and achieving relatively high rates of return. Given all the headaches from operating in a low-margin and low-growth open web market, it seems reasonable to imagine Google selling the Network businesses and reallocating the cash into various AI investments.
For instance, let’s say Google takes the $13 billion today from outside buyers, invests in AI, but gets zero return over the next five years. Starting six years from now, those investments will generate the same ~45% ROIC investors are used to getting from Google. In that scenario, Google turns $13 billion in cash today into $27 billion in present value cash which is a 117% internal rate of return.
Assuming outside buyers would come out of the woodwork for Google’s Network business(most likely from private equity?”), Google would turn a low-margin DOJ adtech headache into a huge shareholder return.
What about YouTube?
Selling the Network businesses is one game move for Google to mitigate DOJ risk while simultaneously increasing the probability of generating future shareholder value maximization. Another interesting game move is to open up YouTube ad inventory to outside DSPs. Given what we know about YouTube’s gross revenue and take rates, and applying key value drivers based on a composite comparable by combining Meta and Netflix as a single entity (more the comparable later), YouTube’s fair market value on a discounted economic profit basis is $147 billion (does not include the value of YouTube subscriber business).
YouTube is the biggest player in the CTV space growing at a 19% CAGR over the past five years and 15% YoY in 2024. It seems plausible and at least worth some consideration that the DOJ’s next move could be looking at YouTube as an overly dominant CTV player. Given the DOJ’s current display advertising case, while also considering the DOJ’s search case, and the aforementioned valuation of various assets, Google could make various pre-emptive moves creating a multi-party win.
Community Review
It’s impossible to predict how things might turn out, but certainly fun to think about and debate as a community. You can review the working paper PDF by downloading it here.
If you would like to review and add comments or questions to the public Google Doc version, request access here. This is where all the fun happens!
If you prefer having a private version for commenting one-to-one with Quo Vadis, DM me here and or send an email to quovadis@lemonadeprojects.com.
Disclaimer: This post, and any other post from Quo Vadis, should not be considered investment advice. This content is for informational purposes only. You should not construe this information, or any other material from Quo Vadis, as investment, financial, or any other form of advice.