Youku and Tudou have been described as the Coke and Pepsi of China’s online video world. So the announcement last week that the fierce competitors planned to merge came as a surprise to many.
To hear Victor Koo, the chief executive of Youku, China’s top online video site, tell it: “[The deal is] to establish a clear and dominant leadership in the online video sector in China.”
To that end, his company is buying Tudou, the number two, in an all-share transaction.
After the deal – reckoned to be worth $1.1 billion – Youku shareholders will own 71.5% of the combined company, and Tudou shareholders 28.5%.
That outcome – skewed in favour of Youku – suggests a victory for Koo in the video wars.
Demand for online video is growing quickly in China, where young people prefer the fare on offer online to broadcast television. That is also one of the explanations for why Chinese internet users spend twice as long on online video than netizens in other countries.
Advertisers follow accordingly. In the last quarter, Youku’s revenue rose 103% to $49.1 million. Tudou’s went up 70% to $26.5 million.
Although revenues have been growing, costs have been rising faster. The biggest drain is bandwidth, for which the online video companies pay China Telecom and China Unicom, the state-owned fixed-line telecoms operators.
Also increasing is the cost of content. Unlike YouTube, which relies on user-generated material, Youku and Tudou either buy or produce the majority of their own content. And it has been getting more expensive, often due to the wider group of competing sites bidding up programme prices. Youku, for instance, saw its content costs treble last year, to Rmb243 million ($38.5 million).
Youku and Tudou have also had to respond to the entrance of better-funded web giants like Baidu and Sohu into the online video market. According to research firm Analysys International, Youku accounted for about 22% of online video advertising revenue in the fourth quarter of last year, while Tudou had a 14% share. But Sohu and Baidu were closing in with 13% and 6.9% respectively.
As the new challengers grab share, the rivalry between Youku and Tudou became more acrimonious. The two have been locked in a legal battle over copyright issues, both accusing the other of improper use of exclusive material. Just last month there were reports that Youku had filed a fresh lawsuit against Tudou, again alleging copyright infringement.
With profitability still elusive, consolidation was an obvious next step. In fact, there was speculation last spring that Youku might acquire Tudou although nothing materialised, says 21CN Business Herald. Analysts also speculated that it was only a matter of time before Tudou became a target for a deeper-pocketed rivals like Tencent and Baidu.
Youku outmuscles Tudou
As both companies look similar, why does Youku seem to have emerged as the senior partner in the deal? Probably because it was the better financed of the two. Youku’s cash and cash equivalents stood at $586.8 million as of the end of last year, compared with $138.5 million at Tudou. Of the two firms, Tudou was also struggling more to control its operating costs, which were escalating. Revenues were up 70% in its most recent results, but costs increased by 119%. For Youku, expenses were being managed a little better: in the same period revenues rose 103% while operating expenses went up by 108%.
When the time came for deal negotiations, Youku would have been a little less desperate.
Timing also worked in Youku’s favour when it beat Tudou to become the first Chinese video website to be listed in the US, raising $203 million. Investors were excited: after the IPO in December 2010, Youku’s market value shot up to $60 a share, the best first-day performance for a US-listed IPO since 2005 (somewhat less euphorically, it now trades below $25).
Tudou’s road to IPO was far from smooth. Although it eventually listed in August last year, the deal was delayed for a crucial period by a lawsuit filed by the former wife of leading shareholder Gary Wang.
The final timing meant the Tudou IPO wasn’t met with the same enthusiasm that greeted Youku’s, and it raised much less at $174 million. Share price performance since has been weaker, too. Unlike Youku, Tudou’s stock was down from its IPO price the first day it started trading. When the news of the merger was announced the site was still trading below its offering price.
All of this matters to the final outcome, which is an all-share deal.
Pros and cons
Presumably, both sides will call a halt to their legal squabbles, ending their distracting dispute.
Joining forces should also help the two to reduce costs and increase advertising prices.
Youku’s Hong Kong-born Koo told analysts that the new entity will have “the most comprehensive content library, the most advanced bandwidth and the strongest monetisation capability in the sector”.
Indeed, in terms of the range of drama, film and sports content that the pair now offer, it is probably better to think of the duo as China’s largest on-demand TV station.
Being able to bid together for new content from Hollywood or sports rights will be beneficial too.
Koo also says the new combination has the largest user base. The numbers are big. In December Youku had 263 million unique visitors, reports the Wall Street Journal. In the same month, iResearch thought that Tudou had 227 million. Tudou has also said that 5.2 billion videos were watched on its site in December alone – double the figure for the previous year.
Despite its scale, the new combination is not going to dominate the sector. “After this merger there are still too many players in the industry,” Michael Clendenin, managing director of Shanghai-based RedTech Advisors, told Reuters. “These are not small, insignificant players. So even though this is a step in the right direction in terms of consolidation, there’s still a long way to go.”
Bill Bishop, an independent analyst based in Beijing, agrees that the deal may not be the game-changer that some believe: “This creates China’s biggest video site, but it doesn’t create a YouTube – they still have less than a 50% market share.” (Google-owned YouTube has an estimated 800 million unique users per month.)
The two companies also know that profitability looks unlikely for the foreseeable future.
For the time being, the merger is mostly taking place at boardroom level. The two sites will continue to function as separate entities (Youku.com and Tudou.com will exist as they are, both under separate URLs).
That means a series of competing or overlapping interests, especially in the licenced TV and movie content that the two sites have already purchased.
Despite this, the two companies say the merger will help save up to $60 million a year in costs.
Will more savings be possible? Reportedly, the Tudou chief executive, has already told his own staff that there won’t be any layoffs. More than that, Wang has promised them pay rises, with speculation that there was minimal consultation with Koo before he made his commitment. Insiders say Wang’s move was designed to show his new boss that he was still in control at Tudou, despite the takeover (for a profile of Wang, who has climbed Mount Everest, see WiC84).
If true, it doesn’t sound like an auspicious beginning for the newly- merged firm. Doug Young, author of China Business Blog, says an immediate priority for Koo is to decide how to rein in Wang. “The companies didn’t say how much of a role, if any, Wang will play at the new company. But I suspect he may try to stay and run Tudou as his own fiefdom, which could cause problems over the longer term,” he warned.
Then again, the merged entity’s new name – Youku Tudou – probably suggests Koo is in the driving seat.
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