UPDATE 4-Youku to buy Tudou, creating China online video giant

Mon Mar 12, 2012 9:52am EDT

* Merged company to be biggest player in China online video

* Two companies had been battling over copyright issues

* Deal size estimated at over $1 billion

* More consolidation in sector seen - analysts

By Kazunori Takada

SHANGHAI, March 12 (Reuters) - China's top two online video companies are joining forces, with Youku.com buying smaller rival Tudou Holdings Ltd in an all-stock deal worth over $1 billion, creating an industry leader with more than a one third share of a market that is losing money as it battles rising costs.

The two U.S.-listed firms have been bitter rivals, locking horns in courtroom battles over alleged copyright infringement and unfair competitive practices.

Both companies have this month reported a net loss for last year, pinched by rising costs for Internet bandwidth, content and mobile video services.

Bringing the two together is a good move for a highly competitive industry with many players fighting over more than 450 million Internet users, analysts said.

"This creates China's biggest video site, but it doesn't create a YouTube - they still have less than 50 percent market share," said Bill Bishop, an independent analyst based in Beijing.

Youku currently leads the fragmented Chinese online video market with a 21.8 percent share, ahead of Tudou's 13.7 percent, according to Internet research firm Analysys International.

"We know online video is way too competitive. There are 10 players, where there should be only one to two," said Michael Clendenin, managing director of Shanghai-based RedTech Advisors.

"After this merger there are still too many players in the industry," he said, noting others in the market such as Sohu.com Inc, Baidu Inc, and Tencent Holdings Ltd , which is trying to develop an online video platform.

"These are not small, insignificant players. So even though this is a step in the right direction in terms of consolidation, there's still a long way to go," Clendenin added.

Far from stifling competition, though, one rival even welcomed the move.

"From an industry perspective, Youku and Tudou's deal is conducive for the healthy development of the sector," iQiyi, Baidu's online video platform, said in an email to Reuters.

"The cost of purchasing copyrights in the market will be more effectively controlled with fewer ... online video companies. It will also reduce the competition for bandwidth and market talent."

TUDOU SHARES JUMP

Once the deal is completed, the combined entity will be named Youku Tudou Inc, and headed by Youku chairman and CEO Victor Koo. Tudou's CEO Gary Wang will join the new entity's board of directors.

As of Friday's close, Youku's market value of around $2.85 billion was six times that of Tudou. Under the terms of the deal, Youku stock and ADS holders will own around 71.5 percent of the new company, with the rest held by Tudou shareholders and ADS holders.

The merger will save the new firm $50 million-$60 million per year over the next 18 months, although it will maintain two separate platforms, which cater to different audiences, executives from the two companies said.

"The fact that we are the two strongest brands in the market, the content scale as well as the ability to have two differentiated brands ... will make us both much stronger competitors," Koo said in a telephone conference.

Koo, also the founder of Youku, which was formally launched in 2007, added that the merged firm is targeting to out-grow other competitors in the market although he declined to comment on when the firm was expected to break-even.

Founded in 2005, Tudou, which means potato in Mandarin and alludes to the image of an Internet couch potato, focuses on user-generated content and producing its own drama serials.

In pre-market trading on Monday, shares of Tudou, which is 9 percent owned by Sina Corp, nearly tripled to $44.09 from Friday's $15.39 close. Partly reflecting the tough competition, Tudou shares, which debuted in August, had consistently traded below their IPO price of $29 each.

"It (the deal) is a sign of how difficult this market is and both companies have probably realised how hard the road ahead would be if they went the independent route," said Bishop. "It should help them get to profitability. Tudou's earnings were released last week and were horrible."

"I imagine this will help other companies in the sector that are trying to list, by reviving interest in the sector. It will also pull up other stocks such as Renren, which could now become takeover targets," he added.

The two firms have sparred publicly in recent months, with Youku filing a lawsuit against Tudou earlier this year seeking 4.8 million yuan ($762,000) in compensation, saying it incurred losses because of claims by its smaller rival that Youku had misused copyrighted material, the official Xinhua news agency reported in February.

The row began in December when the two firms traded accusations of stealing and reposting videos from each other's sites.

Goldman Sachs, Allen & Company LLC and China Renaissance Holdings Ltd are financial advisers for Youku, the two companies said in statement.

Morgan Stanley acted as lead financial adviser and Credit Suisse as co-financial adviser for Tudou on this deal, they said.

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