Is It Time for Alphabet to Spin Off YouTube?

By Markets Fool.com

YouTube attracts over 1 billion visitors per month. Can new investments bring big profits and an eventual spinoff? Credit: YouTube.

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YouTube already has an ad-free subscription service called YouTube Red. Next up: a full-fledged TV subscription service with content from major networks. According to The Wall Street Journal and Variety, the Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) subsidiary has already signed a content deal with CBS (NYSE: CBS). Similar arrangements with 21st Century Fox and Walt Disney Co. are apparently also in the works.

If these reports are accurate -- and with multiple, credible sources weighing in, there's no reason to believe they aren't -- then we could be witnessing the first steps toward YouTube spinning off into a separate entity.

How it could look

Wait. Who says a spinoff is even necessary? No one is saying that at the moment, but among the various subsidiaries controlled by Alphabet, none are positioned so independently as YouTube, which has its own CEO in Susan Wojcicki.

And that makes sense when you look at her peers. Warner Bros. has its own CEO, Kevin Tsujihara, despite operating as a subsidiary of Time Warner. Peter Rice is CEO of Fox Networks Group. Ben Sherwood is President of ABC Television. When you're building a worldwide TV acquisition and distribution business, you organize like one and budget like one.

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Wojcicki also talks like a network executive. At a recent Fortune event, she said that YouTube is still in "investment mode" and that declining TV viewership among 18- to 34-year-olds is a massive opportunity. She noted that, after spending years "trying to get into the living room," YouTube is now "everywhere with mobile phones."

She's right -- the numbers are staggering. More than half of YouTube's 1 billion monthly users watch on a mobile device, with each viewing session now averaging over 40 minutes. The site also claims to serve "more 18-34 and 18-49 year-olds than any cable network in the U.S." Designing a mobile-accessible network that bypasses traditional cable to deliver TV anywhere there's Wi-Fi could be attractive to CBS and other networks, which have largely struggled to control how mobile viewers consume their content via custom apps.

For example, CBS's iTunes app gets just 2.5 out of five stars. There are more than 38,000 ratings of the app, which speaks to the demand for mobile access to network TV. CBS and its peers just can't seem to deliver the experience viewers want, whereas YouTube has spent years serving billions.

How Google Fiber could fit in

How would an independent YouTube serve CBS, Fox, and others? By creating an all-inclusive subscription service accessible wherever there's an internet connection. Think of it more like Hulu than Netflix, but using the same familiar YouTube interface. The service's massive library of snippets and free videos could offer preview content to encourage subscriptions.

Delivery is where this gets really interesting. Because YouTube has been, and will continue to be, an internet-driven service, there's an obvious and natural partnership with the Google Fiber team and the hardware gurus working on Google Wi-Fi. A national gigabit wireless network would allow millions of cord-cutters to get the programming they want. YouTube's subscription TV service would substitute for typical cable in that setup, delivering network programming, but in a format and price that's familiar to the most mobile consumers.

Sound good? Not so fast. Variety mentions that a deal to bring NBC programming to YouTube isn't as close as readers of The Journal story would like to believe, and that makes sense.

Comcast wouldn't be eager to encourage cord-cutters by putting its best programming on YouTube. But if we get to the point where Alphabet, or another company, figures out how to deliver gigabit broadband cheaply across the country, it'll be tough for Comcast, or any cable operator, to keep customers paying the same premiums they pay today. Inking a deal with an alternative distributor like YouTube makes sense at that point.

Until then, a YouTube subscription service would face not only competitive pressure, but also regulatory scrutiny, as cable operators cry foul over unfair competition, citing Alphabet's advantages of "bundling" connectivity with a deeply discounted subscription TV service, while also controlling the bulk of the advertising on said network.

And they would have a point... which brings us back to the rationale for a spinoff. Organizing YouTube as its own company with the freedom to use different ad platforms or strike diverse bundling deals may create just enough distance from its one-time parent to satisfy regulators and stymie lobbyists. Either way, it's an interesting and potentially catalytic time for YouTube -- and for the shareholders who own a piece of the business via Alphabet stock.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Tim Beyers owns shares of GOOG, GOOGL, NFLX, TWX, and DIS. He also has the following options: long January 2017 $85 calls on DIS. The Motley Fool owns shares of and recommends GOOG, GOOGL, NFLX, and DIS. The Motley Fool recommends TWX. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.