As they cheer the proposed marriage of China's two largest online video companies, investors in Youku and Tudou Holdings should make sure to thank the Chinese government's censors. Because of the policy preventing Web surfers in China from visiting Google's YouTube, the country's cybercops created an opening for Made-in-China alternatives.

Youku and Tudou have taken advantage of YouTube's absence and now account for 52 percent of China's total Web video traffic, according to Mirae Asset Securities analysts Eric Wen and Nancy Yang. On Monday, the two companies announced that Youku would acquire Tudou, its smaller rival from Shanghai, in a stock-only deal worth $1 billion.

The purchase is just the latest sign of the powerful growth of China's Internet sector. There are more than 500 million Chinese online, according to the official Xinhua news agency, an Internet penetration rate of close to 40 percent. With the country's traditional media dominated by clunky, state-owned companies that are hard-pressed to create entertaining programming, that huge Internet user base helps provide companies like Youku and Tudou with a foundation for future growth.

"In the long run, all television will be Internet television," write Wen and Yang in a Tuesday analysis of the acquisition. "Television's user interface will merge with the Internet, giving online video companies a much larger market to play with."

For now, though, Youku, Tudou and online video rivals such as Sohu.com and Qiyi, backed by Chinese search engine Baidu, are struggling to turn popularity into profits. Youku's fourth-quarter sales more than doubled to $48.6 million, the Beijing company announced this month. The torrid growth isn't showing signs of slowing: Youku forecasts that revenue will likely double again in the first quarter of 2012. Yet in the fourth quarter of 2011, Youku lost $7.8 million.

With at least 10 major players trying to become the YouTube of China, too many companies are competing for the same viewers, says Michael Clendenin, managing director of Shanghai market research firm RedTech Advisors. Companies try to outdo one another by creating original programming, which means costs are soaring and profit margins are terrible.

"These look more like steel companies than Chinese Internet companies," Clendenin says. "The costs for online TV companies are very high - and you can't reuse the inputs."

That's one reason some venture capital investors are looking to other parts of China's cyberspace for opportunities. Even with hundreds of millions of Internet users, China until recently has lagged in e-commerce because of problems dealing with such matters as logistics and online payments. Those obstacles are now disappearing, according to a recent report by Bain & Co.
 

Source:entgroup