In May, I wrote about Alphabet (NASDAQ:GOOG) and the three reasons Alphabet stock is a long-term buy. One reason I liked its chances over the long haul was the increasing sentiment for Alphabet to spin off YouTube, its wildly successful video platform. 

A couple of months later and not much has changed, including its share price, which has gone nowhere over the 61 days since. 

There’s not much in the way of news to report about YouTube heading into Alphabet’s Q2 2024 results. They will be released on July 23 after the markets close. 

However, YouTube Music did launch new sound search capabilities that allow users to hum a song and it finds the song from a catalog of more than 100 million. It’s like Apple’s Shazam.

It announced that it’s experimenting with AI-generated conversational radio, which allows you to describe what you want to hear and YouTube’s AI finds examples that fit your description.

As European regulators continue to push for Alphabet to break itself up, here are three reasons why a YouTube spinoff makes sense sooner rather than later.  

YouTube Would Be Attractive to Investors

In my May article about Alphabet, I highlighted Needham analyst Laura Needham’s $423 billion market valuation of YouTube. In early July, she had more to say about YouTube’s valuation and regulators. 

“‘We believe that [Alphabet] is worth more in pieces than together,’ Martin concludes, ‘so we welcome regulators’ attempts to break up’ Alphabet,” Barron’s reported on July 5. 

The analyst believes that YouTube outside Alphabet would be worth 50% more than its value within the tech giant. Even a partial spinoff would, in her estimation, add 8% to the valuation of Alphabet stock, which she pegs at a $210 target price, considerably higher than where it’s currently trading. 

Based on Needham’s $423 billion valuation, it would be the ninth-largest stock in the Nasdaq 100 market capitalization.

And even if you fully extracted YouTube from Alphabet, the former parent would still have a market cap of nearly $2 billion, keeping it in sixth spot in the Nasdaq 100. 

YouTube’s Revenues Continue to Grow

In 2023, YouTube’s ad revenue was $31.5 billion, Martin estimates, growing 13% to $35.5 billion in 2024. 

In 2023, Meta Platforms (NASDAQ:META) ad revenue was $131.6 billion, excluding currency. With total revenue of $134.5 billion, excluding currency, it’s valued at 16.4x sales. If YouTube got the same P/S ratio, its market cap would be $574 billion, $151 billion higher than Martin’s estimate. 

As Barron’s points out, YouTube led the streaming platforms for hours viewed in 2023 at 9%, 50 basis points higher than Netflix (NASDAQ:NFLX). More importantly, it commands ad rates per thousand impressions that are 30-50% higher than Facebook and Instagram, so it’s possible the $574 billion valuation could also be low.

Martin’s valuation suggests YouTube’s ad revenue is worth at least $355 billion, but could go as high as $625 billion. Ad in $175 billion for its subscription business, which includes YouTube TV and YouTube Music, and you’re up to $535 billion, $112 billion higher than her valuation in May. 

Unfortunately, Alphabet’s current enterprise value is 6.3x sales or $350 million, nearly $200 billion less.  

The Alphabet Stock Takeaway

One of the words that is often mentioned when discussing spinoffs is “focus.” The idea of adding by subtracting. Were Alphabet to split into three businesses – Google Cloud, Google Search, and YouTube – capital allocation and growth initiatives for each business would be more focused as three independent companies. 

The downside of this is that the three businesses would no longer have each other to lean on if one or more areas have a downturn or face unexpected headwinds. It’s a benefit of having multiple revenue streams. 

The upside of such a move is that investors are able to better evaluate each business given separate reporting of quarterly financials and management discussions. As Martin points out, money is getting left on the table because of the undervaluation of YouTube. 

The reality, however, is that all three businesses are likely leaving money on the table, which is why investors often use the sum-of-the-parts valuation method for complex businesses.

I don’t think there’s any question Alphabet would add value for shareholders by spinning off part or all of YouTube. Doing it sooner rather than later would also end any regulatory breakup talk.

Alphabet stock remains a buy. 

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

On the date of publication, the responsible editor did not have (either directly or indirectly) and positions in the securities mentioned in this article.