Youku Tudou Finds Benefactor In Alibaba

Alibaba buys into Youku Tudou

Just a day after getting some extremely worrisome news that could see many of its most popular offerings censored, leading online video site Youku Tudou (NYSE: YOKU) has announced a more positive development in the form of a $1.22 billion investment led by e-commerce leader Alibaba. The move is part of Alibaba’s recent buying binge, which has already included a handful of investments of this size, as it tries to get into every area of the Internet imaginable. The tie-up does have some positive elements that could help Youku Tudou, and comes as a slight surprise since media were reporting just a month ago that the company was preparing to sell a similar stake to Alibaba rival Tencent (HKEx: 700).

Before we look at this latest deal, we should review the news from yesterday that saw Chinese regulators suddenly order the removal of 4 popular US television series from domestic online video sites. (previous post) No explanation was given, but many fear the move could presage a broader crackdown that could see online content placed under the same strict review rules that TV shows, music and film get when they are broadcast over traditional media channels.

The announcement sparked a sell-off for publicly listed companies that rely heavily on online video. Youku Tudou tumbled 5.5 percent, while Baidu (Nasdaq: BIDU) and Sohu (Nasdaq: SOHU), which own the nation’s second and third largest sites, fell 7.4 percent and 6.7 percent, respectively. The drop collectively shaved off hundreds of millions of dollars in shareholder value, and reduced Youku Tudou’s market capitalization to $3.8 billion.

That market value figure is quite important here, since Youku Tudou’s valuation looks much higher based on terms of the newly announced Alibaba purchase. That deal will see Alibaba and another investor, Yunfeng Capital, purchase 16.5 percent and 2 percent of Youku Tudou, respectively, for a total of $1.22 billion (company announcement) A little math will show that purchase price values Youku Tudou at about $6.6 billion, or nearly twice as much as its current market value based on its stock price.

It’s not unusual to have some discrepancy in market values when you get a deal of this size, but in this case the gap is rather larger. One could argue that Alibaba has massively overpaid for its Youku Tudou stake, or that Youku Tudou itself is massively undervalued, or perhaps a combination of the two. The fact that Youku Tudou’s shares sank so much even after Alibaba’s investment was announced indicates investors are most worried about the potential damper on Youku Tudou’s business under the new censorship regime.

From a strategic perspective, this deal does have quite a few positives. It will allow Youku Tudou to remain independent under its current management that is relatively strong, since Alibaba has no meaningful video business right now. The 2 could also find synergies in Alibaba’s recently launched Internet TV product, which could provide a lucrative channel for Youku Tudou’s video content.

At the same time, Alibaba is showing an increasingly worrisome tendency to pay big premiums for its purchases, probably because it has far too much cash and not enough places to spend it. The company bought a major stake last year in leading microblogging site Weibo (Nasdaq: WB) that valued the company at $3.3 billion, and yet Weibo is now worth just $3.6 billion more than a year later after a recent high-profile IPO. If I were an investor, I would say that Alibaba almost certainly overpaid again for its Youku Tudou stake, though perhaps by less than the current gap suggests. That means the recent sell-off is probably overblown, and we could see some upside for the company’s stock in the next few months.

Bottom line: Shares of Youku Tudou could see some upside in the next few months, following a major investment by Alibaba that values the company at nearly twice its current market capitalization.

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