Yahoo Might Be Making Another Mistake With Hulu

| About: Yahoo! Inc. (YHOO)

Ask most people what they think of Yahoo (NASDAQ:YHOO), and you'll encounter a lot of cynicism. Once a search giant, the company has clearly taken a backseat to Google (NASDAQ:GOOG), and now faces the challenge of deciding what areas of business it should reach into beyond its main business. YHOO has made numerous acquisitions and business moves into various industries over its history, but it could certainly be argued that the company has not had a strong history of making smart decisions when it comes to acquisitions. Some of the biggest examples of businesses that YHOO overpaid for are (for $5.7 billion in stock in 1999), GeoCities for $3.6 billion in 1999 and Overture for $1.63 billion in 2003, together with a plethora of smaller acquisitions.

Most recently, the YHOO acquisition of Tumblr for $1.1 billion has also been met with substantial cynicism, as Tumblr has been known to have an extremely young demographic (largely teenagers) and rather questionable content. That acquisition could be compared to Facebook's (NASDAQ:FB) acquisition of Instagram, which came at a similar price point. It is possible (though still impossible to predict) that Tumblr will, in fact, prove to have been a smart acquisition for YHOO, or it could just go the way of YHOO's other disappointing acquisitions (personally, due to the fact that Tumblr is fairly easily replicated and given the fickle nature of its users, I don't have high hopes for it). But what interests me most now is the possibility of YHOO making another major acquisition: that of Hulu. The news that YHOO has been bidding for Hulu was first announced by AllThingsD, who says that numerous sources close to the situation have reported that YHOO has bid between $600 million to $800 million for Hulu.

The Pros of Hulu: Proven Revenue and Easy Integration With YHOO

Hulu is a video streaming website that makes money off advertising and subscribers who pay to watch TV shows that Hulu hosts. It is my view that Hulu seems like a relatively sensible acquisition for YHOO compared to Tumblr, and that YHOO would be able to integrate Hulu into its existing services quite well, especially since YHOO already has its hand in the online video streaming business (according to ComScore, Yahoo! Sites accounted for over 45 million unique viewers in April 2013). And most importantly, Hulu has proven it has a viable model. With around 4 million subscribers paying $7.99 per month, Hulu clearly has a far more attractive revenue stream than Tumblr.

Of course, if YHOO takes control of Hulu, there is still the real possibility that it will run Hulu into the ground, or Hulu could fail even with perfect management. The main risk is that Hulu's business model relies heavily on access to exclusive content, and changes to the price of content or lack of content rights in future will pose a serious threat to its future. In the past, Hulu has been able to strike exclusive deals with major broadcast networks (FOX, ABC and NBC), but there's no guarantee that this will continue. Hulu's primary competitor, Netflix (NASDAQ:NFLX), faces a similar issue and also competes with Hulu for exclusive content. Although Hulu has strong and consistent revenue, it must be understood that due to its reliance on a few major content providers, its revenue source is easily fallible.

A YouTube Parable

Hulu is not entirely similar to YouTube, which relies on user-uploaded content, makes money off advertising only (paying a portion of advertising revenue to partners who have highly-viewed videos) and does not have an option to pay for premium content. However, while there are numerous differences between the two websites, they are still in the same basic industry (online video streaming), and it's instructive to take a look into the YouTube acquisition by Google in 2006 for $1.65 billion in stock.

While YouTube has remained the dominant video sharing website, there's been serious concern that it has been a white elephant for Google (among the critics are billionaire Mark Cuban who considers the deal a huge mistake). In earnings reports, Google does not provide any details regarding YouTube's running costs, which would be substantial (some estimate YouTube's running costs to be between $5 million to $6 million per month). In a 2007 filing, YouTube's revenues were noted as "not material," and many estimates say YouTube is still losing money (a report from 2009 estimated YouTube could lose $470 million that year). While we don't have the details of YouTube profits or losses, it seems difficult to foresee that YouTube could ever justify its $1.65 billion price.

A YHOO acquisition of Hulu could play out the same way as Google's acquisition of YouTube, or it could be even worse as Hulu is unable to secure fresh exclusive content (YouTube by comparison does not rely on exclusive content and will always have users uploading new videos).

A Fair Price For Hulu

Due to the uncertainties involved in Hulu's future, it's difficult to put a price tag on it, but we know there has been considerable interest from numerous parties. This is not the first time Hulu has entertained buyout offers - in 2011, it was reported that larger offers were made, including one from Dish at $1.9 billion - and given the competition, it still seems unlikely that YHOO will wind up owning Hulu. YHOO shareholders just have to hope that YHOO doesn't get silly and make an overly generous offer as they have done on past acquisitions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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