Post The Latest Alibaba Youku Acquisition, Sell Youku Now And Buy Alibaba Stock

  • In spite of the recent Alibaba Youku acquisition at a 35% premium, Youku's asking price has actually declined by ~10% in the last 19 months.
  • This decline likely stemmed from the management's uncertainty towards Youku's growth due to increased costs and rising competition.
  • This acquisition offers no compelling reasons to justify any potential synergies that can lead to appreciation in Youku stock.
  • However, Youku will continue driving traffic to Alibaba's platforms, and help increase the demand for Alibaba Pictures Group.

Alibaba Youku Acquisition

Youku Tudou (NYSE:YOKU) is China's leading internet company building a Hulu plus Netflix for China at a YouTube scale. According to Youku's corporate profile, the company has 200 million unique visitors every month. In addition to that, Youku has a 40% market share in terms of user time spent in China and it is China's third largest website by user time spent. Understandably, Alibaba recently acquired the company.

On November 6, in a Bloomberg article "Alibaba Buys Youku in Deal Said to Be Valued at $4.8 Billion", Alibaba agreed to buy the remaining shares in Youku at a 35% premium to its previous day trading price. This cash deal translated to a $27.60/share. Although this deal seemed to have been at a premium, it is actually at a ~10% discount to the price Alibaba and Yunfeng Capital bought their first shares of the company. On April 28, 2014, the venture Capital Post announced "Alibaba, Yunfeng Capital to acquire stake in Youku Tudou valued (at) $1.22 billion." A deal which translated to $30.50 per American Depository Receipt of the company.

Youku's Business Challenges

The fact that the asking price decreased by ~10% in 19 months should be a testament to how Youku's management perceived the company's potential to succeed in the short term. Youku has a lot of deep-pocketed competitors such as Baidu's iQiyi, Tencent Video and Sohu Video. Having well-capitalized competitors has meant that well-rated shows can sell their content to the highest bidder. This has meant increased costs for Youku to keep its content pipeline at par with the competition, implying that the company has to manage the increased bandwidth costs, content costs and operating expenses amidst shrinking margins. It is these challenges that created uncertainties towards Youku's success moving forward. Hence the reason why the company was bought at a discount and the reason why investors should not buy the stock at current levels as the risk/reward profile is skewed against them.

The first reason why the risk/reward profile is skewed against investors is because Youku is currently trading near its 52-week high, but the company has a trailing twelve month profit margin of ~-27% and a trailing twelve month operating margin of ~-28% according, meaning that the current surge in the stock price was based on the fact that the company was an acquisition target and investors wanted to benefit from the premium that accompanies an acquisition. However, the premium advantage is now off the table. The company will have to perform to maintain these new high valuations. Historically, Youku's margins have disappointed and there are no synergies to the deal that suggest that anything different will happen in the short term.

In addition, the acquisition for Youku will require the stock to fall before it can rise again. Alibaba and Yunfeng Capital (co-founded by Jack Ma) already owned ~18.5% of Youku. The two companies already shared a mutually beneficial relationship and given that this mutually beneficial relationship was unable to shield Youku from incurring losses this fiscal year, the acquisition will not suddenly make the margins for Youku skyrocket for it to perform in accordance to its current valuation.

Another question that arises is why would Alibaba agree to pay a 35% premium for a company operating at a loss? The acquisition was a strategic move to hinder Alibaba's rivals from acquiring the remaining shares in Youku. For the Alibaba-Youku relationship to continue uninterrupted, Alibaba needed to secure the remaining shares in the company before another company whose interests and that of Alibaba might be misaligned acquired the remaining shares. The reason for the acquisition was not purely fundamental and hence the reason investors should be aware of the negative implications of a surge in the stock created by this rationale from fear.

Furthermore, there will be a cooling off period as the current rise in Youku's stock price is temporary. After the news of the acquisition settles down, investors will be expecting Youku to deliver on improving its weak fundamentals. Historically the company has not been able to deliver positive margins. There is no guarantee that it will deliver just because it has been acquired by Alibaba.

Lastly, Youku will help drive more traffic to Alibaba's e-commerce sites. This is because Youku offers a "buy-what-you-watch" service that lets viewers buy the clothes that the actors on a show are wearing. Acquiring Youku enables Alibaba to preserve this relationship and also maintain its dominance over online retail in China. In addition, the Youku acquisition will enable Alibaba Pictures Group to expand its revenue streams. This is because, Alibaba can freely integrate content between Youku and Alibaba Pictures Group by showing Alibaba Pictures Group content on Youku. Alibaba Pictures Group will earn profits in the process but also help drive traffic to Youku and subsequently to Alibaba's platforms. In addition, this will act as a platform to allow Alibaba Pictures Group to effectively market its content to consumers. Considering that Alibaba's acquisition benefits are imminent and that Alibaba is trading at ~33% below its 52-week high in spite beating earnings in the last quarter and achieving record sales on Single's Day, Alibaba offers the most compelling bull case with more upside potential and minimal downside risk than Youku.

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  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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