Youku, Tudou: No Honeymoon Ahead 优酷与土豆“婚”後将无蜜月可度

The proposed marriage between Youku (NYSE: YOKU) and Tudou (Nasdaq: TUDO) looks like a done deal, with shareholders of both companies approving the union at separate meetings on the same day. (Youku announcement; Tudou announcement) So now the question becomes: what does the union mean for the longer term development of the new company, Youku Tudou, and also what does the formation of this new industry leader mean for other major players? In a nutshell, I honestly don’t think the future looks very bright for anyone, due to both individual company issues and broader industry issues as well.

Let’s look first at Youku Tudou, which will control around 40 percent of China’s online video sharing market if and when their merger closes, which looks likely after yesterday’s approval by shareholders of both companies. The new company’s biggest rival will be the online video service operated by web portal Sohu (Nasdaq: SOHU), which holds about 15 percent market share, followed by smaller names like PPTV, Xunlei, and LeTV (Shenzhen: 300104), all of which have less than 10 percent.

Let’s start by looking at Youku Tudou, which will face the very real challenge of integration issues after the merger closes. I fully expect Tudou’s top officials, including founder Gary Wang, to step down by the end of this year or possibly sooner, which will remove one of the biggest obstacles for Youku CEO Victor Koo and his new management team. Still, I do predict mass departures of other Tudou staff due to big differences in corporate culture, and I also wouldn’t be surprised if Youku’s managers quickly discovers that Tudou isn’t quite as a strong a company as they previously believed.

All of this is relatively normal for newly merged companies, so none of it should come as a huge surprise. But on a broader basis, both Youku and Tudou were seeing their business slow and losses growing in the last quarter, reversing a previous trend of narrowing losses as each tried to become profitable. That reflects a broader industry trend that isn’t really specific to Youku or Tudou, but instead is related to the video sharing sector in general.

The bottom line is that no one in video sharing, including global leader YouTube, has found a way to earn big profits from the business yet, and there’s no reason to expect that the new Youku Tudou will succeed where others have yet to find a formula for success.

Meantime, we could expect to see the Youku Tudou merger put pressure on some of the other players to merge as well. Sohu looks like the most likely candidate to lead such a drive, but company founder Charles Zhang hasn’t ever done a major merger like this before, partly because he doesn’t like to share control of his companies.

Instead, I would expect to see some of the smaller companies, especially venture-backed firms like Xunlei and PPLive, and possibly Shenzhen-listed LeTV, merge to form a potentially interesting rival to the new Youku Tudou. But even this new company will quickly discover that bigger size doesn’t guarantee success in the difficult video sharing space, and I see difficult times ahead for everyone in the next 2-3 years.

Bottom line: China’s video sharing sector could see more consolidation following completion of the Youku-Tudou merger, but everyone will experience difficulty in the next 2-3 years.

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