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Google makes video play with YouTube buy

YouTube will operate independently and the companies will work together on building new features.

Google has agreed to purchase online video phenomenon YouTube for $1.65 billion in stock, the companies announced Monday.

The deal, which had , will dramatically improve Google's video-sharing service with one of the Internet's hottest properties in YouTube, which allows Net users to upload video clips and share them with the world, for better or worse.

YouTube will operate independently, and the companies will work together on building new features for independent users as well as for aspiring directors, they said in a press release. The deal is expected to close in the fourth quarter of 2006.

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YouTube: Google's biggest buy
After announcing a $1.65 billion purchase, Google CEO Eric Schmidt and YouTube CEO Chad Hurley look forward to what the combined company can do.

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"This is one of many investments that Google will be making to put video at the heart of a user's online experience," said Google CEO Eric Schmidt on a conference call after the deal was announced. "When we looked at the marketplace and saw what was going on, we saw a clear winner in the social networking side of video, and that's what drove us to start the conversations with YouTube."

From the YouTube side, co-founders Chad Hurley and Steve Chen described their excitement at taking advantage of Google's deep pockets and advertising contacts as they continue to build out their site. "We now have the resources to take our service to the next level," said Chen, who serves as YouTube's chief technology officer.

Google's acquisition of YouTube comes as online video is really starting to hit its stride. As more and more people have signed up for broadband Internet connections and the technology behind video-sharing services has improved, traffic to YouTube's site has skyrocketed. The site has about 45 percent of the online video market, according to recent figures from Web traffic monitor Hitwise.

Steve Chen Steve Chen

Users have made a very big deal of uploading videos of themselves, sharing the minute details of their lives, dancing to popular music or, more controversially, rebroadcasting clips of popular television shows.

One early example of the phenomenon was the frenzy around the comic "Lazy Sunday" video, pulled from an airing of "Saturday Night Live." NBC first demanded that YouTube pull the sketch from its site after people flocked to the hilarious rap song featuring two mild-mannered cast members affecting gangsta-rap personas while recalling a trip to the movies to see "The Chronicles of Narnia." But YouTube later cut a deal with NBC to allow YouTube users to post content from NBC programs, and it has followed up that deal with others involving companies such as Warner Music and on Monday, Universal Music Group, Sony BMG Music Entertainment and CBS.

Google's heft gives YouTube more credibility in this emerging market for online video, said Josh Bernoff, an analyst with Forrester Research. "I think the combination of the greater potential to make deals and also the greater technical ability to solve copyright problems puts them in a much better position than YouTube is (in) by itself."

Chad Hurley Chad Hurley

Around 100 million videos are available on YouTube on a given day, with 65,000 new videos added every day, according to the company's Web site. It cited numbers from Nielsen Net Ratings, claiming 20 million unique visitors a month.

All of that content requires search technology to make it easier to find exactly what users are looking for, and improving YouTube's search capabilities with Google's technology will be one of the first priorities of the merged organization. But Google also sees advertising possibilities in those numbers, said Sergey Brin, Google's co-founder and president of technology. "Video is a great medium for advertising," he said.

The companies struck an all-stock deal in order to make the transaction tax-free for the YouTube shareholders, according to David Drummond, senior vice president of corporate development for Google. Google will issue the number of shares required to complete the deal based on the 30-day average closing price of Google's stock two trading days prior to the close of the acquisition. The company's stock closed at $429 on Monday. Sequoia Partners provided the original funding for YouTube of $3.5 million in November 2005, and followed that up with a second $8 million round of funding in April.

You Tube videos

YouTube's suitors over the last six months have, according to reports, included Microsoft, Yahoo, News Corp. and other online and traditional media giants looking to get in on the viral video craze. However, the process of trying to determine YouTube's value over the last six months reminded more than a few analysts of the dot-com bubble frenzy in the late 1990s, when companies were being purchased based on a user base and a dream, regardless of whether they were actually able to turn a profit.

Google used a "synergistic" model to value YouTube, said Drummond, declining to elaborate on just exactly what that meant but acknowledging that traditional "standalone" methods of putting a price tag on the company were hard to use in this situation.

Executives pointed to the similarities between a young YouTube and a young Google as one of the reasons for the acquisition. "Everyone here knows they've built an extraordinary business and phenomenon. The thing that tipped us over was not business success or working relationships but the vision of serving users," Schmidt said.

Still, the combined organization will need to make money serving those users. The early strategy appears to be a combination of targeted advertising next to YouTube videos combined with better search technology for helping content owners identify copyright violations. "We're going to be exploring a lot of options utilizing Google's advanced ad technology that benefits the experience and helps partners monetize their content," said Hurley, YouTube's chief executive officer.

With this move, Google has launched itself ahead of competitors such as Yahoo and Microsoft in taking control of online video, Forrester's Bernoff said. "Every one of these portals now of any size has announced its own user-generated content area, it's apparently very easy to put in place, but that doesn't help much. The people at YouTube have figured out how to do this better, and I think the other portals have to implement a system similar to this to be successful," he said.

Microsoft was looking into buying something like YouTube earlier this year but eventually decided to build its own video sharing service, known as Soapbox, according to Whitney Burk, a spokeswoman for the company. "We are excited about the potential we are seeing in the beta of Soapbox on MSN and believe building our own solution is a more cost-effective way to compete in this new space," said Burk in a statement.

CNET News.com's Anne Broache contributed to this article.