YouTube has always had more viewers than Netflix (NASDAQ:NFLX), but now the ad-supported streaming service is set to generate more revenue than the leading subscription video on demand platform this year. Last quarter, the Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) subsidiary and Netflix generated nearly the same amount of revenue — just over $7 billion — but YouTube is growing significantly faster.
Here’s why YouTube will overtake Netflix’s revenue figures in 2021 and what it means for investors.
Previewing the second half of 2021
After everyone and their mother signed up for Netflix in 2020 amid the coronavirus pandemic, Netflix is suffering a bit of a hangover in 2021. To be fair, management warned that would be the case, as it pulled forward subscribers into 2020 that it expected would eventually sign up, but perhaps in 2021 or beyond.
As such, subscriber growth has been lean so far this year. CFO Spencer Neumann does, however, expect the fourth quarter to produce more typical subscriber growth as it laps the impact of COVID-19 and releases a strong content slate. His third-quarter outlook calls for just 3.5 million net additions and revenue of $7.5 billion.
YouTube, meanwhile, has seen continued strength in its execution and it’s benefiting from a couple secular trends. More people are watching YouTube and specifically watching it on their main screen — a television. Management said 120 million Americans watched YouTube on their TV last quarter during the Q2 earnings call. That’s up from 100 million in the second quarter last year.
Moreover, YouTube is riding the acceleration in digital advertising spend. And it’s in connected TV, one of the faster-growing segments of digital advertising. YouTube has the scale and technology to win an outsize portion of connected TV advertising without sacrificing ad inventory to the distribution platforms. That makes it one of the few streaming services that can fully capitalize on the connected TV trend.
On top of that, digital ad spending is typically skewed toward the back half of the year. As such, investors should expect YouTube revenue to keep climbing through the fourth quarter, significantly outpacing the growth at Netflix.
Through the first six months of the year, YouTube’s ad revenue totaled $13 billion. It also had about 3 million YouTube TV subscribers generating around $1 billion in revenue. Netflix subscribers paid it $14.5 billion through the first half of 2021. Given the trends, investors should expect YouTube’s full-year revenue to surpass Netflix’s.
What about profits?
Alphabet doesn’t share its operating profits from YouTube specifically, but they may be comparable to Netflix’s. The company pays out 55% of its revenue to creators — about $3.85 billion in the second quarter. Netflix’s content amortization expense totaled $2.8 billion in the second quarter, but that number should climb in the second half of the year as it works through the production bottleneck caused by COVID-19.
On top of that, Netflix also has significant marketing expenses, which totaled $600 million last quarter. It also likely incurs higher content delivery expenses because it uses a third-party cloud provider while YouTube benefits from its sister company’s cloud.
All told, operating profits for the two companies probably don’t look too dissimilar, and the edge may go to YouTube. Netflix’s operating margin in the second quarter was 25%, but management expects full-year margin to come in closer to 20%.
What it means for investors
YouTube is generating more revenue than Netflix and growing faster, and it may even be more profitable. As such, it should trade at a premium to Netflix if it were a stand-alone company.
But it’s not likely Netflix is grossly overvalued at today’s stock price. Just two of 41 Wall Street analysts rate the stock as underperform or sell and the average price target is $611.
More likely, YouTube is currently undervalued. Netflix’s enterprise value is around $250 billion. Alphabet’s is around $1.73 trillion, but it also has a massive advertising business outside of YouTube generating six times the revenue and higher profit margins. On top of that, it houses a mobile services business (Android and Google Play), a burgeoning cloud computing segment, a hardware business, and its “other bets.”
There’s a case to be made that Alphabet is still undervalued while trading near its all-time high stock price, and the market’s underestimation of YouTube may be one reason why.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/08/26/news-flash-youtubes-about-to-leave-netflix-dust/