Youku acquiring Tudou rumor signals cost and copyright problems in online video market

It’s rumored that Youku is planning acquire Tudou in the wake of the latter’s IPO halt. According to people involved with Tudou’s IPO process, the company has been drifting apart from investment banks, “With ever-rising copyrighted content prices and competitors has gone(Youku) or about to go(Xunlei, PPStream) IPO, the only way Tudou’s investors could make a nice exit might be selling Tudou to someone else. ”

Time is running out

Tudou had signed valuation adjustment mechanisms (VAM) with Singapore-based Temasek Holdings in its $35 million dollars worth of Series E funding last August. Under the terms, if Tudou failed to be listed this year, its founder and management team would possesses less stakes after dilution caused by Temasek’s justified holding of more stakes.

Sky rocketing costs…

Costs of copyrighted films and teleplays are rising sharply due to successful IPO of online video sites, Youku for example.  At the same time, other big names such as Sohu, Qiyi, Xunlei and Tencent all strived to purchase copyrighted content, driving up the content acquiring costs. According to a recent report by Goldman Sachs, costs related to copyrighted content purchasing of Youku would rise up to RMB 2.7 billion(US$ 41million) in FY11, while its FY10 net revenues were RMB 387.1 million(US$ 58.7 million). And Sohu video had already purchased some hit TV serials from U.S. and South Korean broadcasting company, eg. The Big Bang Theory by CBS and Gossip Girl by The CW Television Network, among other quality contents. Qiyi, the Chinese Hulu, was rumored to spend up to RMB 1 billion on quality copyrighted content last year. Qiyi CEO Gong Yu didn’t confirm such claims, but he did mention that Qiyi’s #1 cost is bandwidth, with content (#2) and manpower cost (#3) come after that. Qiyi also got online broadcasting right of Desperate Wives and Grey’s Anatomy with an undisclosed sum.

…paired with widening losses

Chinese online video market has been experiencing copyrighted content wars since 2009. PPTV CEO Tao Chuang said that, for some video sites, content costs accounted for one third of its operating costs. “The trends of ever-rising copyrighted content costs would be a disaster (for online video sites) if it’s not appropriately dealt with. ” said Gong Yu. According to officials from Sohu, Ku6 and Youku, costs of home-made prevalent TV serials has doubled in 2010. According to Ku6’s FY10 earnings release, the Shanda online video subsidiary is losing lots of money. Net loss was US$ 51.5 million in the fiscal year 2010, up from  the previous year of net loss of US$ 23.4 million. We believed that highly soaring content costs and other expenses caused Ku6’s big loss.

With respect to other players, Xunlei started to use newly-bought domain Kankan.com in the latest sign of its eagerness and dedication to dig deeper into Chinese online video market. While Tencent just released its revamped video site with the announcement of the set up of a RMB 500 million worth of fund focus on investing in TV serials, film projects or early stage production houses.

As the big ones are busy doing their shopping, some minor names are busy with shoplifting.

OpenV, for instance, was charged with copyright infringement, six people including one of its VP was arrested for this matter.  Sohu and Qiyi paid their dues to get quality content to lure visitors, while the smaller players like Kaiyu Video, Xingou VOD, Miss Video, and Fangcaodi Video, among 40 other sites, are still offering pirated contents. We have reasons to believe that 2011 will be the year of copyrights-safeguarding, as long as more and more big guys have a stake in quality content. They might even join forces together against such manners.

Youku / Tudou pairup: if not Youku, who else?

I think Xunlei and Ku6 would be potential candidates in the acquisition, given Xunlei’s financial health and Ku6’s backing from parent company. However, with a magnificent 74% of market share in the download software market in China, Xunlei could easily turn its enormous client users into Kankan.com’s regular visitors. I believe the domain shifting is a part of the effort of getting prepared for going public this year. Xunlei will file for IPO in the States this year, planning to raise up to US$200 million.

And Ku6 has Mr. Chen Tianqiao’s Shanda as its backup. Earlier this month Shanda announced that it has agreed to invest USD 100 mln in Ku6 in the form of ordinary shares and senior convertible bonds for the sake of the latter’s business expansion, working capital and other general corporate purposes. Ku6 founder and CEO Li Shanyou resigned from the company last month because of the strategic divide between him and Mr. Chen. Li advocated buying more quality copyrighted content — aka Hulu model – while Chen insisted on video news and information model.

As for Youku and Tudou merger, some people believe that such move will benefit both the bidder and vendor, as Youku would have access to Tudou’s customer base and traffic and content costs would also be reduced after the merger. But, don’t you think these two are largely overlap in terms of business scope? If Youku is serious about buying something, I think another video site with huge client user base would be a better choice, as in Ku6’s acquisition of Pipi (www.pipi.cn). Pipi, a Hangzhou-based company, owns an online video site and Pipi Player, the client software for streaming contents on Pipi.com. Shanda holds stakes in both Ku6 and Pipi.

Ku6 Acquisition of Pipi Signals Future Trends of Video Website-Client Integration

As we know, search engines, clients, and direct visits are among the major traffic sources for video sites. Search engine might easily divert traffic as in Baidu-Qiyi case. Grasping Tudou in hand might not helping with that. On the other side, owning a streaming client would prevent search engine from diverting traffics, since search engines could not get in the way between users and websites. Client software can perform as direct traffic source. This might put Ku6 in a better position to compete in the online video market.