YouTube's sale to Google signals Internet's arrival as mass media

By DAN FOST
SAN FRANCISCO CHRONICLE

Google's blockbuster recent announcement that it would pay $1.65 billion in stock for YouTube, an online video company that has yet to turn a profit, pumped air into the theory that another Internet bubble has inflated.

Certainly tech's new boom has many similarities to the dot-com days of the late 1990s, when millionaires rode their scooters through the corridors of short-lived startups and companies with little or no real revenue were commanding obscene valuations on Wall Street.

Upon closer inspection, this latest Internet run-up has a deeper grounding, with millions of people online -- and millions of dollars in advertising being spent to reach them.

"A gigantic gush of consumer products advertising dollars is moving online," said Paul Kedrosky, a venture capitalist and author of the Infectious Greed blog. Consumer product companies represent 11 percent of the $145 billion global advertising market, but they spend only 1 percent of their ad budgets online, Kedrosky said.

"That's absurdly low," he said, but it's changing, and "a gigantic sluice is opening up."

Much of the first bubble, which reached a feverish pitch before popping in 2000, was based on speculation about how big the Internet would become and what kind of companies would make big money on it.

While that speculation still exists, no one now disputes that the Internet has changed the way much of business is conducted, to say nothing of how people interact or how entertainment is broadcast.

And the Internet has been broadly adopted, with the Pew Internet and American Life Project finding that 42 percent of Americans have high-speed Internet connections at home, and nearly three-fourths of all U.S. adults are regular Internet users.

"I absolutely think we're in a bubble, but the bubble we're in is very different," said Joe Kraus, chief executive officer of JotSpot, a company that provides software that businesspeople use for collaboration.

Kraus knows bubbles: He founded Internet portal Excite, a classic example of the first dot-com go-round that included a stratospheric stock offering and a sobering collapse.

"A huge number of companies are being created and funded right now," Kraus said. "It's so much cheaper to bring a product to market these days."

That means entrepreneurs don't need to go to the public market. Kraus said too many "fifth-tier" companies had big public stock offerings in the late 1990s, which he doesn't see happening now. Wall Street drove much of what then-Federal Reserve Board Chairman Alan Greenspan termed "irrational exuberance." It was the onset of a bear market that finally burst the bubble.

"The great thing in this bubble is it's not accessible to retail investors," Kraus said. Last time, "investors like my Mom and Dad could invest in speculative companies. My Mom and Dad have no access this time. It's all funded by private capital and private equity. The only people who get hurt are people who can afford to get hurt."

According to venture capital research firm Dow Jones VentureOne, 49 "Web 2.0" companies received $262.3 million in the first half of 2006, compared with 51 companies getting $199 million in all of 2005.

VentureOne defines Web 2.0 companies as those consumer-oriented Web sites with open interfaces specializing in user-generated content and social networking.

But Web 2.0 still represents a tiny portion of where venture capitalists are putting their money. Overall, according to Josh Grove, a senior research analyst at VentureOne, firms invested $13 billion in a range of industries, primarily the more traditional tech mainstays such as software, semiconductors, hardware, networking, and biotech and medical devices.

A growing chorus is arguing that Google's deal for YouTube makes perfect sense.

George Zachary, a partner at venture capital firm Charles River Ventures, compared the deal to Microsoft's acquisition of Hotmail in 1998 for a reported $400 million, saying that people thought the software giant overpaid, only to see Hotmail become a hugely popular e-mail service.

In an almost parallel argument, Kedrosky, of the Infectious Greed blog, compares the YouTube deal to Disney's purchase of Fox Family Worldwide in 2001 for $5.3 billion. That deal made sense, he said, because it was a media deal.

"People are in the bad habit of looking at YouTube as a technology company," he said. "It isn't. ... It's a media company."