By Chen Jing

Tudou and Youku, who have always appeared to be wrangling with one another over copyrights issue, took everyone by surprise this time. The two online video tycoons announced recently that they had signed a finalized agreement on March 11 to merge through a 100 percent stock swap. It is estimated that the deal involves an amount of US$ 1.04 billion, making it the largest stock swap merger in China's internet market ever. For the online video industry, which has been the focus of attention in internet industry in the last year, this deal is no less than a powerful industrial earthquake.   

According to statistics of market researcher Analysys, in China's online video market, Youku accounts for 21.8 percent and Tudou 13.7 percent in terms of revenue share. Who is playing the leading role in the merging of the two largest players of the industry? What kind of conditions of the online video industry does the merger reflect? What are the subsequent changes in the future?

Who's the dominant one, Tudou or Youku?

According to the ultimate agreement between Youku and Tudou, the new company after the merger will be named Youku Tudou Inc; Youku shareholders and holders of American depositary shares (ADS) will own about 71.5 percent of the new company's share, and Tudou shareholders and holders of American depositary shares will get the remaining 28.5 percent. When the contract takes effect, all issued and outstanding A shares and B shares of Tudou will be delisted, and each share converted into 7.177 shares of Youku's A shares. Youku will continue to be traded on the New York Stock Exchange. The merger is expected to be completed in the third quarter of 2012. Thereafter, Tudou's brand and platform will remain independent. 

Judging from shareholding scale and Tudou's delisting, we can see clearly that Youku is the buyer and Tudou the seller in this deal. From the perspective of the buyer, the offer of Victor Koo, founder, Chairman of the Board, and CEO of Youku, is really munificent. Before the announcement, Youku closed at US$ 25.01 on March 9 on the American stock market, and the stock price of Tudou was US$ 15.39. This means that Tudou's stock price appreciates by 159 percent as per the final agreement. After the announcement, Tudou's stock price surged, closing at US$ 42.5 on March 13. 

As for the seller, there had been news that Baidu was inclined to acquire Tudou before its IPO in August last year. Later, rumors of a "gossip" between Tudou and LETV.com arose. Wang Ran, CEO of China eCapital, the company that provided service to the merger of Youku and Tudou, disclosed that Tudou had been in touch with industrial magnets about capital cooperation long ago. Tencent, Baidu, and Sina were all on Tudou's candidate list. After Tudou contacted Youku, however, both parties managed to reach an agreement within one month, due to the similarity of their business models and a clear pattern of merging. The deal makes Tudou the Chinese internet company that has the shortest time from its listing to its delisting.
Then, why is Tudou anxious to sell itself? And why is Youku eager to merge Tudou? 

Sticking together to shake off distress

Not being able to go any further on the money-burning path is the main reason why Tudou is being acquired. Zou Shenglong, CEO of online video site Xunlei.com, told the reporter: "Tudou's choice of a merger has its reason on the cash level as well as on the capital level. It is still hardly possible for the online video industry to make profit in the near future. Tudou doesn't have sufficient cash reserve to continue the money-burning; besides, the overall conditions of the capital market are not good enough, and it would be difficult for Tudou to refinance. Being acquired is a good option for Tudou". Tao Chuang, CEO of video site PPTV, suggests that the growth of traffic to Tudou.com slowed down in last year; in addition, Tudou faces fierce competition of copyright purchase in the market, and its cash supply is tight; therefore, Tudou chooses to merge with Youku. Indeed, according to its financial statements, Tudou suffered a net loss of RMB 140 million Yuan in the fourth quarter of 2011, RMB 15 million Yuan more than the same period of the previous year. 

Besides, it seems that capital has played an important role to make the merger possible. According to Tudou's ownership structure, Wang Wei, founder and CEO of Tudou, holds about 8.6 percent of the company's stock and only 25.4 percent of voting rights; the several bigger shareholders before him are VC institutions such as IDG China and GGV Capital. The founder holds a rather small portion of the company's share, and has rather weak control over the company. Xie Wen, a senior internet observer, said that after Tudou's IPO, its' share price had been slipping, and judging from its profit and revenue, there won't be significant change in the near future. Six months after its IPO, the lock-in period of some VC expires, and capital is eager to retreat; however, it's hopeless for the capital to exit through the open capital market, so they have to help to make the sale possible in order to retreat.

For Youku, the situation is not optimistic either. According to its financial reports, Youku's net income in the fourth quarter of 2011 was RMB 393 million Yuan, an increase of 103 percent over the same period of last year; after adjustment, the net loss was RMB 34.1 million Yuan. With expensive copyright fees and without more profit approach nowadays, Youku has no choice but to form ally through merger, in a bid to gain more say in price negotiation by increasing its traffic. However, most portals direct the traffic into their own online video site. Sohu has the tv.sohu.com, and Baidu has its iqiyi.com. So, Youku can only choose to acquire vertical video sites. In this regard, Tudou, who has received investment from Sina before and is working extensively with Sina's Weibo.com, is apparently the best choice. Moreover, Tudou is well-known for its superiority in users' self-developed contents in the industry: up to 40 percent of Tudou's traffic is generated by self-developed contents. Its business is somewhat complementary to Youku's model. 

Change of copyright fee and advertisement price

The merging of Youku and Tudou significantly concentrates the online video industry. This gigantic new entity will outdistance the secondary battalion by several degrees. Nevertheless, most online video sites welcome the news. Xu Weifeng, CEO of video website PPS, suggests that, for PPS, the merger between Youku and Tudou is a good thing, because it means that they have one less rival on the market now. Liu Hong, COO of LETV, also believes that the deal between Youku and Tudou is conducive to the differentiated development of the entire industry, and other mainstream video sites will gain more market shares. 

What gives video websites a great relief is that the meager would significantly change the way the online video cake is made and shared. Regarding cost, Gong Yu, CEO of Baidu's video site iqiyi.com, puts it this way "Finally, a more beautiful tomorrow is dawning". He suggests that: "The reduction in the number of video companies puts a restraint on the rather expensive copyrights trading market. Other rigid costs, such as server bandwidth and human resource competition would also be significantly reduced". As for income, market researcher iResearch believes that: "the value of advertisement will increase significantly, and the price will rise, too". Other video sites will also benefit from the deal.