What Alibaba Can Gain From The Youku Tudou Acquisition

  • Youku Tudou shareholders are due to meet in a week's time to vote on the proposed buyout by Alibaba.
  • Several proxy advisers have encouraged Youku Tudou  investors to approve the merger.
  • What will the buyout of Youku Tudou  bring to Alibaba's table?

With just a week to go before Youku Tudou (NYSE:YOKU) shareholders meet on March 14 to vote on whether or not to approve the proposed buyout of the company by Alibaba (NYSE:BABA), influential proxy advisers ISS, or Institutional Shareholder Services, and Glass Lewis have advised Youku Tudou investors to give thumbs up to the merger. Alibaba has agreed to pay $27.60 per American depositary share for Youku Tudou in a deal valued at $4.8B ($3.67B net of Youku Tudou’s cash). That’s 35% above Youku Tudou’s share price the day before the deal was announced.

Youku Tudou, aka the YouTube of China, will become one of Alibaba’s biggest acquisitions to-date. Alibaba has never been known to shy away from buying companies as it tries to cover as many e-commerce bases as possible, though few are of Youku Tudou’s stature. So why is Alibaba doling out billions for this video site?

First, let's look at Youku Tudou’s financials. Youku Tudou finished Q3 2015 with net revenue of U.S. $291.8 million, good for a robust 62% Y/Y growth. The company’s bottom line, however, is a different story. Youku Tudou reported a net loss of U.S. $68.5 million, more than doubling the loss the company had posted during the previous year’s comparable quarter. This probably has something to do with high content costs.

Meanwhile, Alibaba finished the last quarter with revenue of $5.33B, up 31.9% Y/Y, and net income of $1.92B, up 112% Y/Y. Youku Tudou will, therefore, add about 5 percentage points to Alibaba’s top line growth.

So, obviously, Alibaba’s chief interest in Youku Tudou cannot be merely to spur inorganic growth. The biggest reason why Alibaba wants to buy Youku Tudou is possibly to lay its hands on the platform’s 290M users and possibly add them to its own 390M users. Youku Tudou sports a cheap Price-to-Sales ratio of 4.9 compared to Alibaba’s 16.9. Alibaba will, therefore, be getting all those Youku Tudou users on the cheap. Of course, it’s possible that there is a large degree of overlap and many Youku Tudou users already use Alibaba’s e-commerce platform to do their shopping. Assuming that half of Youku Tudou already use Alibaba’s platform while the rest do not, Alibaba will still be able to acquire these users at a considerable discount compared to its own users.

Alibaba wants to cover all e-commerce bases, and so far it has been lagging behind its rivals in web video. Baidu (NASDAQ: BIDU) already has iQiyi, a video platform with more than 275M users. With more than 460M users, the Chinese online video industry is just too big for an e-commerce company like Alibaba to ignore. Youku Tudou fits perfectly in Alibaba’s multiscreen strategy that ensures that its users are engaged across multiple channels including mobile, desktop, and other smart devices. Once the two companies merge, Alibaba will be in a position to leverage Youku Tudou’s user data to lure its users to shop on its platform.

Unlike YouTube, Youku Tudou mostly streams professionally produced content instead of amateur content. This explains why the company’s losses are expanding due to high content costs, but is also the reason why Youku Tudou has a rapidly growing recurring revenue stream. Youku Tudou reported $40.3M in subscription revenue during the last quarter, or about 14% of total revenue. In contrast, YouTube relies almost exclusively on ads for its revenue. Youku Tudou’s subscription revenue jumped 514% Y/Y during the last quarter, a clear indication that users are happy to pay for the platform’s videos. Despite the impressive growth, there is still room for improvement. The company recently announced that it plans to collaborate with U.S. entertainment producers to help it improve the quality of content on its platform. This is likely to help Youku Tudou gain an international audience that can pay higher subscription fees which will hopefully allow the company to finally become profitable.

Investor Takeaway

Alibaba’s purchase of Youku Tudou seems like a solid buy. The video platform will not only help Alibaba to grow its user base cheaply but also help the company compete better with its rivals with well-developed online video channels. Meanwhile, Youku Tudou is growing at a healthy clip and might be able to become profitable by improving the quality of content on its site.

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