Youku Tudou: A Buyout Target?

Youku Tudou: buyout ahead?

I decided to write about leading online video site Youku Tudou (NYSE: YOKU) today after reading a new report that says the company has posted a hefty 1.77 billion yuan ($290 million) in losses since its New York IPO 4 years ago. A little math will show that translates to average losses of about $20 million in each of the approximately 15 reporting quarters since it went public in December 2010. Much has changed in China’s online video space over that time, including a recent regulatory campaign to stop Youku Tudou and its peers from competing directly with traditional TV stations.

I don’t know how other investors feel about this company, but I would certainly be losing patience at this point with Youku Tudou. After a period of improvement, its losses now seem to be getting worse again due to all the rapid regulatory changes. That’s been putting pressure on the company’s stock, and prospects for improvement over the next 1-2 years don’t look too good either. Accordingly, I wouldn’t be surprised to see a wealthy buyer make a bid for Youku Tudou in the next year, with the newly listed and obscenely rich Alibaba (NYSE: BABA) as the most likely buyer.

Following a period of rapid M&A over the last year that saw most of its money-losing rivals acquired by bigger firms, Youku Tudou is now the only major stand-alone online video company in China. Its second largest rival iQiyi is owned by search giant Baidu (Nasdaq: BIDU), and the third largest firm is owned by web portal Sohu (Nasdaq: SOHU). Other big names are also owned or controlled by other big names like Internet giant Tencent (HKEx: 700) and electronics retailing leader Suning (Shenzhen: 002024).

The report that caught my attention says a big portion of Youku Tudou’s nonstop losses stem from the landmark merger 2 years ago of Youku and Tudou, then the industry’s 2 largest players, to form the current company. Many observers thought Youku paid too much for Tudou, and I personally predicted post-merger problems due to the 2 companies’ very different management styles. The new reports say Tudou has been losing money ever since the merger.

More recently, Youku Tudou and rivals like iQiyi and LeTV (Shenzhen: 300104) have been caught up in a steady clampdown against them by the nation’s broadcasting regulator. That campaign is almost certainly in response to the companies’ growing encroachment onto the turf of traditional TV broadcasters, as the video sites rolled out new TV and set-top box products that allowed their programs to be watched over traditional televisions. The latest step in that crackdown has reportedly seen the regulator order video sites to withdraw all TV apps for their services.

Youku Tudou’s shares have been on a turbulent ride since the company’s public offering in 2010. The stock originally rose more than 5-fold from its IPO price of $12.50. But more recently it’s tumbled sharply, and now trades at about $18 — still 50 percent above its IPO price but a fraction of its earlier highs. The company still has plenty of cash, about $1.6 billion to be precise. But its losses are growing again and the regulatory uncertainty casts big doubts over its ability to survive independently over the longer term.

Unlike other Chinese Internet firms, whose founders’ big egos often obstruct M&A, Youku Tudou is headed by the very pragmatic CEO Victor Koo who generally puts business ahead of personal pride. The company already sold nearly 20 percent of itself to Alibaba and a related investor earlier this year, as it sought a longer-term strategic partner. (previous post) With all the changes now happening in the space, I wouldn’t be surprised to see Koo sell his company outright in the next year to Alibaba, which has plenty of cash for such a purchase following its wildly successful IPO last week in New York.

Bottom line: Youku Tudou’s uncertain prospects due to a rapidly changing regulatory environment could make it a prime takeover target, with Alibaba as the most likely buyer.

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