Beijing Crackdown Boosts Legal Video

Beijing cracks down on pirated video sites

A new crackdown on Chinese websites that traffic in pirated material is coming as welcome news to China’s struggling online video sharing sector, where companies are still struggling to find success in a tough market. But while it’s easy to blame the pirates for their woes, China’s money-losing video sharing sites are also simply victims of choosing a sector where earning profits is extremely difficult if not impossible. That reality is reflected in the fact that sector pioneer YouTube still struggles to earn money, even some eight years after it was first established.While the road ahead for them looks difficult, China’s online video firms must certainly have welcomed news of the latest crackdown by Beijing law enforcement officials late last week on World Intellectual Property Day. (English article) The series of raids looks like the result of painstaking advanced planning, as law enforcement officials descended on at least 5 major sites that traffic in pirated movies, TV shows and other copyrighted material.

The crackdown included not only the shutdown of sites, but also detention of executives and employees from some of those sites. That’s quite an important development, since previous raids often result in closures and even some fines; but they seldom end with any arrests or criminal charges, with the result that pirates often simply move their websites and pirating businesses elsewhere.

This latest crackdown is clearly at least partly a publicity ploy, similar to another series of investigative TV reports that uncovered other misdeeds by Chinese firms on national Consumer Rights day last month. At the same time, I do have to commend China for showing it’s serious about cracking down on the pirates in such a high profile way. As a longtime China resident, I can say with confidence that this crackdown has been happening for much of the past decade, with the result that most pirated DVD stores have been closed in big cities like Shanghai.

Investors cheered the latest website crackdown, bidding up battered sector leader Youku Tudou (NYSE: YOKU) by more than 6 percent in Monday trade to just over $20. Still, the shares are at just a third of their level from 2 years ago, when they soared to more than $60 at the height of a China Internet bubble. Overseas-listed Chinese Internet companies have been on a steady downward trajectory since then, with money-losing companies like Youku Tudou getting an especially cold shoulder from investors.

It’s still unclear if these pirating websites will remain shut, or will simply reopen later at different web addresses. But even if the shutdown is long-term, it’s far from clear that China’s legal video sharing sites will become profitable anytime soon. Observers currently debate whether YouTube is profitable, with many saying it may be marginally in the black but probably doesn’t make huge contributions to the bottom line of its heavyweight parent, global search titan Google (Nasdaq: GOOG).

If even YouTube is having trouble earning profits, imagine how difficult the road ahead will be for the big Chinese names. Those include not only Youku Tudou and the video site operated by web portal Sohu (Nasdaq: SOHU), but also a potential major new rival being assembled by Chinese search leader Baidu (Nasdaq: BIDU) through its pending purchase of PPS, the industry’s third largest player.

Youku’s founder and chief executive Victor Koo said in an interview over the weekend that his company has adjusted its strategy to focus on original content creation and mobile platforms, in an apparent move away from its previous approach of licensing movies and TV shows from third parties. In that same interview he refused to forecast when his company might become profitable, indicating to me that profits are at least 2 years away.

At the end of the day, this latest crackdown by Beijing can only be viewed as positive new for the sector, since it will eliminate many rivals that use pirated material to unfairly compete with names like Youku Tudou. But I still have serious doubts about the long-term prospects of this sector, and suspect that many players could ultimately get acquired by bigger names from other areas, much the way that Google purchased YouTube in 2006.

Bottom line: Beijing’s crackdown on online piracy is good news for legal video sharing sites, but those sites will still face an uphill road to profits in the difficult space.

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