Youku: A Closer Look at the YouTube of China

by Tony D'Altorio

Youku: A Closer Look at the YouTube of China

by Tony D'Altorio, Investment U Research

Tuesday, March 8, 2011

One of the most successful recent IPOs has been Youku ADR (NYSE: YOKU), China's largest online video company, it raised $233 million back in December.

Its shares gained 161% on their first day of trading. That's the biggest jump in the U.S. market since Baidu ADR (Nasdaq: BIDU), China's leading online search engine, went public in 2005.

But it's no wonder Youku did so well, since many investors call it the "YouTube of China."

It allows users to upload their own content, though it mostly broadcasts film and programming licensed from movie studios and TV companies. Hence why it sees itself comparable to Hulu, NBC Universal, Fox Entertainment and ABC's joint venture.

Many investors believe that Chinese sites like Youku have huge potential. But those investors might want to look before they leap...

China's Online Video Market

Despite some choppy trading, Youku's stock has remained relatively strong since its IPO. But that's not because of good news.

Like other online companies, Youku has yet to make money and reported a fourth quarter net loss of $5.7 million. Though that's 18% better then the hit it took in the same period the previous year, it was still worse than expected.

Youku also gave current quarter expectations of a 105-115% revenue hike over the same period last year. That's a drastic slowdown from the prior 183% quarter's growth rate.

Yet management remains upbeat, pointing to its 15-20% advertising rate raise this year. It also highlights its triple-digit revenue growth as a "clear path to profitability."

Unfortunately, industry participants estimate that online video sites in China attract less than 5% of the country's online ad spending. Besides, those businesses face plenty of risk, such as fierce competition.

  • For instance, Youku's trailing competitor, Toudu, is also expanding its exclusive content.

  • And Beijing itself is ramping up online video operations of its state media group.

  • Even - the online video site set up by Baidu - CEO Gong Yu has called the industry "unhealthy." The U.S.'s Hulu, on the other hand, can be considered profitable.

What's more, Chinese internet companies face risks from government regulators. China recently tightened strict internet censorship - again - after an anonymous online call for pro-democracy rallies in the country.

Finally, many Chinese users still won't pay for content. They have even easier access to pirated content than the U.S. does, making it harder for the industry to profit.

Youku: An Internet Stock For Lazy Investors

In short, Chinese internet stocks like Youku are classic buys for lazy investors.

They look good at a glance, since China has a mere 34% national internet penetration rate. And with cheaper bandwidth too, shouldn't every internet company with market share make money eventually?

Yet the most optimistic analysts expect Youku to make 24 cents of net income per share in 2013. This puts it on a multiple of 173 times that year's earnings, a modest target that still might not be realistic.

Since its founding in June 2006, Youku has shifted its focus from getting user content to making content itself or buying it from media companies. Those costs - which are expected to rise - made up a fifth of net revenues last year, up from about a tenth in 2009.

And competition will likely just make that showing even poorer...

More Chinese webcasters are shifting to Hulu-type, video on-demand models like Youku's. And Mega-portals Sina ADR (Nasdaq: SINA) and Tencent ADR (PINK: TCEHY) might soon join the fray.

Youku could, of course, crush them all. But why gamble on the possibility?

YouTube's owner, Google (NASDAQ: GOOG), makes a much smarter play. It's only trading at 13 times 2013 expected earnings... 13 times less expensive than Youku.

Good investing,

Tony D'Altorio

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