Watch Out, Flash; Google Buys On2

Google (s GOOG) today announced it bought On2 Technologies (s ONT) in a stock-for-stock transaction worth $106.5 million. On2 has historically been a core underpinning of online video with its encoding and compression technologies. However, the company is not an obvious pick for Google, especially given that its main VP6 product is much less dominant than it used to be. The purchase makes it evident that Google is preparing to make a video infrastructure play.

Just about everyone that powers online video or has their own Flash player, including Adobe (s ADBE), continues to pay On2 licensing fees for its VP6 video codec. However, in the last couple of years, the industry has largely chosen H.264 as VP6’s successor. Though H.264’s selling point is its high quality, a big part of the reason people moved away from VP6 was those On2 licensing fees. “It was like dealing with Tony Soprano every year,” said a source today. “If you were a day late…It was archaic licensing. It was just a nightmare.”

Still, VP6 is already installed on computers everywhere, and with Google managing its licensing (or even dropping it), the format could come back into power. The open-source video compression format of choice, OGG Theora, which is being pushed by Mozilla, has not won industrywide confidence, so it could be that Google is trying to substitute another contender. Google, with its Chrome browser, is one of the leaders of the new HTML 5 standard, which handles video natively and could eventually eliminate the need for Flash and Silverlight-type plug-ins.

Google Vice President of Engineering Vic Gundotra demonstrated YouTube mocked up in HTML 5 at a recent developers’ conference. There’s no indication YouTube will trade in Flash just yet, but clearly that’s figuring into people’s long-term visions. However, another funny twist is that, at least according to our source, YouTube itself is thought to use an open-source version of VP6.

We wouldn’t be surprised if Google goes ahead and open-sources On2 itself. From the press release:

“Today video is an essential part of the web experience, and we believe high-quality video compression technology should be a part of the web platform,” said Sundar Pichai, vice president, Product Management, Google. “We are committed to innovation in video quality on the web, and we believe that On2’s team and technology will help us further that goal.”

Shares of Google are essentially flat, off less than 1 percent at $449.98, while shares of On2, which is traded on AMEX, have rocketed higher by 49.7 percent to change hands for 57 cents. Adobe shares, meanwhile, are down 3.5 percent to $31.84.